The most widely-reported result of the recent G-7 meeting was Japan’s attempt to convince the other major economies to admit that a crisis is imminent and take appropriately radical steps. The response seems to have been a bunch of blank stares. As India’s Business Standard noted:
Abe’s counterparts, understandably, do not share his view that the world risks another Lehman Brothers-style financial crisis. That is important because Abe has inexplicably committed to raising the country’s sales tax next April, a surefire way to choke off recovery – unless a shock of this scale emerges.
So Japan — which, remember, has already borrowed eye-popping amounts of money, increased its central bank balance sheet by more as a percent of GDP than have either the Fed or ECB, and pushed interest rates on most of its government bonds into negative territory, all to no avail — has decided to act on its (manifestly justified) sense of panic by starting a new round of deficit spending:
Abe will seek a second supplementary budget worth 5 trillion yen to 10 trillion yen after July’s upper-house election, the Nikkei reported Saturday without attribution. Proposals will include accelerating the construction of a magnetic-levitation train line from Nagoya to Osaka, issuing vouchers to boost consumer spending, increasing pay for child-care workers and setting up a scholarship fund, the Nikkei said.
“When you want to get the economy going, as long as demand in Asia is weak, you need additional public spending,” Martin Schulz, a senior economist at Fujitsu Research Institute in Tokyo, said by phone. “Since private spending is still not picking up, the government is simply taking up the slack.”
The stimulus package would be the second this fiscal year after Japan approved a 778 billion yen supplementary budget this month to aid recovery from earthquakes in the Kumamoto region.
And about that tax increase…
While the tax hike was seen as critical to reining in Japan’s massive public debt, Abe and his aides have signalled the chance of deferring it as Japan’s economy skirts recession and a threat of deflation re-emerges ahead of summer upper house elections.
“We’ve reached a global agreement to cooperate to avoid another big crisis from erupting … As G7 chair, Japan will spearhead such moves to contribute to the global economy using all policy tools available,” Abe told reporters after the Group of Seven (G7) leaders’ summit in western Japan on Friday.
“We must reignite powerfully the engine of Abenomics. That undoubtedly would include a decision on what to do with the sales tax hike,” he said, offering his strongest hint yet that next year’s tax hike will be delayed.
What does this mean? In a nutshell, the next phase of the global economic crisis has begun. First, governments responded to the 2000 tech stock crash with lower interest rates and big deficits. Then they responded to the housing/banking/derivatives bust of 2008 with even lower interest rates, bigger deficits and experiments like QE. Then they responded to the resulting anemic recovery with negative interest rates and more QE.
None of the above has produced the kind of growth in the US, Europe or Japan that slows the upward march of debt/GDP, which means everyone is still digging their own financial graves. Since this is not an acceptable long-term strategy (eventually the sides of the hole cave in and bury you), something else has to be tried by the people who hope for re-election a few years hence. So now we’re back to massive deficits, but with a negative interest rate twist. Think about it: When a government issues negative-rate debt, it earns a profit on the transaction. And when it sells its debt to its own central bank it in effect owes the money to itself. A site called Forex Live just published an interesting analysis of this unprecedented situation:
It just so happens that inflation and a decline in the currency are exactly what many governments want.
In the developed world, inflation is non-existent and the currency war rages. The trump card in that game is default via monetization and it’s coming.
The dominant ethos of the past 25 years has been a drive towards fiscal discipline. Politicians and political commentators have built their reputations and careers as misers. There is something inherently, almost pathologically wrong about defaulting.
That will all change.
The idea of default sounds like it would create panic; if not in the streets then in markets. But it’s easier than you might assume and it will happen sooner than you think.
The hard part is already done. It’s simply a matter of taking the debt the central bank already owns and writing it off. To ease the shock value of it, the debt will simply be converted into bonds the central bank will continue to ‘own’ but will have 0% coupons and no maturity.
Japan will be the first to do it
Japan is a demographic nightmare and has been unable to stir inflation for the past 20 years despite zeroed out rates. The debt-to-GDP ratio is a mind-blowing 227.9% with a fresh stimulus budget coming. There is no way out.
At the moment, the BOJ owns 35% of Japan’s government debt and at the current pace of buying it will hit 63.3% at the end of 2020. With the stroke of a pen, all that could disappear.
I don’t even think it would be disruptive. The central bank could launch a new round of QE at the same time as the announcement and keep control of what’s left of the bond market. At the moment, Japanese 10-year are yielding -0.11%. The means you have to pay interest to the government just so they’ll give you your money back in 10 years. Almost everyone who owns Japanese bonds is an insurance company or pension fund that has no other choice.
How do markets react
Governments face hard choices but they will find that monetization is far easier than Eurozone-style austerity (how many governments won re-election after that?) or stalled out growth.
Certainly in the first episode there will be some worries in markets. Gold will undoubtedly rally and the currency will decline. It may even create some inflation.
But like QE, the first forays will be small and governments will quickly fall in love with the ability to spend in ever-larger amounts.
This is disturbing on a lot of levels, but it’s also quite conceivable. When governments figure out that in a world of deflation (caused by the industrial overcapacity and bad debt from their previous policy mistakes) they really can borrow and spend whatever they want — and if it causes inflation, well, great, they win the currency war — then the floodgates will open.
Japan, as it has with past monetary and fiscal insanities, is leading the way. And if history is any guide the rest of us will follow along shortly.