The first article is a fairly technical exposé of Japan’s situation. But in amongst the hard facts are the conclusions to be drawn by all of us from those facts. This is a warning to us too, for, although a way behind, we are pursuing under Brown the same path and could reach the same conclusion unless we stop!
Today a report calls for continuing stimulus while a respected economist calls for more QE . They ought to read this first.
Roger Bootle’s article is appended for comparison. He welcomes what he expects on Thursday - a continuation of QE. This, however, builds up yet more debt and the Japanese experience is a stark warning of not getting fiscal deficits under control.
There’s no easy solution, but the quality of these different viewpoints is high.
Christina
=================================
TELEGRAPH 2.11.09
1. It is Japan we should be worrying about, not America
Japan is drifting helplessly towards a dramatic fiscal crisis. For 20 years the world's second-largest economy has been able to borrow cheaply from a captive bond market, feeding its addiction to Keynesian deficit spending – and allowing it to push public debt beyond the point of no return.
By Ambrose Evans-Pritchard
The rocketing cost of insuring against the bankruptcy of the Japanese state is telling us that the model has smashed into the buffers. Credit default swaps (CDS) on five-year Japanese debt have risen from 35 to 63 basis points since early September. Japan has suddenly decoupled from Germany (21), France (22), the US (22), and even Britain (47).
Regime-change in Tokyo and the arrival of Yukio Hatoyama's neophyte Democrats – raising $550bn (£333bn) to help fund their blitz on welfare and the "new social policy" – have concentrated the minds of investors at long last. "Markets are worried that Japan is going to hit a brick wall: the sums are gargantuan," said Albert Edwards, a Japan-veteran at Société Générale.
Simon Johnson, former chief economist of the International Monetary Fund (IMF), told the US Congress last week that the debt path was out of control and raised "a real risk that Japan could end up in a major default".
The IMF expects Japan's gross public debt to reach 218pc of gross domestic product (GDP) this year, 227pc next year, and 246pc by 2014. This has been manageable so far only because Japanese savers have been willing – or coerced – into lending for almost nothing. The yield on 10-year government bonds has been around 1.30pc this year, though they jumped to 1.42pc last week.
"Can these benign conditions be expected to continue in the face of even-larger increases in public debt? Going forward, the markets capacity to absorb debt is likely to diminish as population ageing reduces saving," said the IMF.
The savings rate has crashed from 15pc in 1990 to near 2pc today, half America's rate. Japan's $1.5 trillion state pension fund (the world's biggest) has become a net seller of government bonds this year, as it must to meet pay-out obligations. The demographic crunch has hit. The workforce been contracting since 2005.
Japan Post Bank is balking at further additions to its $1.7 trillion holdings of state debt. The pillars of the government debt market are crumbling. Little wonder that the Ministry of Finance has begun advertising bonds in Tokyo taxis, featuring Koyuki from The Last Samurai. If Japan's bond rates rise to global levels of 3pc to 4pc, interest costs will shatter state finances.
No one knows exactly when a country tips into a debt compound trap. But Japan must be close, even allowing for the fact that liabilities of the state Loan Programme (FILP) have fallen by 40pc of GDP since 2000.
"The debt situation is irrecoverable," said Carl Weinberg from High Frequency Economics. "I don't see any orderly way out of this. They will not be able to fund their deficit. There will be a fiscal shutdown, a pension haircut, and bank failures that will rock the world. It is criminally negligent that rating agencies are not blowing the whistle on this."
Mr Hatoyama inherited a country that was already hurtling into sovereign "Chapter 11". The Great Recession has eaten up 27pc in tax revenues. Industrial output is down 19pc, even after the summer rebound; exports are down 31pc; the economy is 10pc smaller today in "nominal" terms than a year ago – and nominal is what matters for debt.
Tokyo's price index fell 2.4pc in October, the deepest deflation in modern Japanese history. Real interest rates have risen 300 basis points in a year. It reads like a page from Irving Fisher's 1933 paper, Debt Deflation Causes of Great Depressions.
The Bank of Japan seems oddly insouciant. It will end its (feeble) quantitative easing in December by suspending purchases of corporate debt, much to the fury of the Finance Ministry.
"This is incredibly dangerous," said Russell Jones from the RBC Capital Markets. "The rate of deflation is shocking. The debt dynamics are horrible and there is the risk of a downward spiral."
Tokyo has let the yen appreciate violently – 90 to the dollar, 13 to the Chinese yuan – giving another twist to the deflation knife. Top exporters are below break-even cost, says RBS. The government could stop this, as it did in a wave of manic dollar purchases from 2003-2004. It could print money à l'outrance to stave off deflation. Yet it sits frozen, like a rabbit in the headlamps.
Japan's terrible errors are by now well known. It failed to jettison its mercantilist export model in time. It resisted the feminist revolution, leading to a baby strike by young women. It acquiesced in a mad investment bubble (like China now) in the 1980s, stealing growth from the future.
It wasted its immense fiscal firepower, scattering money for 20 years on half-baked spending projects to keep the economy afloat. QE was too little, too late, and this is the lesson for the West. We must cut borrowing drastically over the next decade, and offset this with ultra-easy monetary policy. Does Downing Street understand this? Does the White House? Does the European Central Bank? Clearly not.
=============
AND
2. More quantitative easing is on the way – and that's a good thing
This week the Monetary Policy Committee (MPC) will decide whether or not to extend its programme of quantitative easing (QE), ie buying assets with central bank money.
By Roger Bootle
The committee has always been more likely to make changes to monetary policy during Inflation Report months, and November is one. Not only does compiling the report allow the committee to update its economic forecasts, but its subsequent publication allows the committee to explain more clearly why it is making any changes.
QE's ghastly name makes it seem completely novel and even outlandish. In reality, though, it is no more than the policy of "open market operations" described in the classic textbook on money and banking by Richard Sayers and advocated by John Maynard Keynes in the 1930s, learned by two generations of students of monetary economics but hardly ever implemented until recently. In the vernacular, it is known by the much more catchy title of "printing money", though hardly any extra notes have been printed.
So far the Bank has purchased around £175bn of assets – most of them gilts. This is a huge sum. The Bank now holds about 20pc of the entire gilt stock. The purchases have caused the size of the monetary base (commercial banks' reserves with the Bank of England plus notes and coin in circulation) to increase by more than 100pc since March.
It seems particularly bizarre because the government is simultaneously issuing gilts. Even if these are not the self-same gilts bought by the Bank, in effect it is financing the government's deficit, albeit not directly. Yet, there is nothing contradictory here. The government needs to issue gilts because it is in deficit and it is a decision of fiscal policy. The Bank's decision to purchase them rather than leave them in the market is an act of monetary policy.
What's the point? To stimulate the economy. There are three main channels through which QE might achieve this. First, it should encourage banks to lend by raising the amount of cash they hold with the central bank. Second, the purchases of the gilts should raise their prices [or stop them falling! -cs] and lower their yields. What's more, coupled with the extra supplies of bank deposits sitting in portfolios earning next to nothing, this should prompt investors to shift their money into other riskier assets like equities and corporate bonds, thus pushing up their prices too – boosting wealth and reducing borrowing costs. Third, the Bank of England's purchases of corporate debt should help to relieve blockages in the corporate credit markets and make it easier for firms to borrow outside banks.
We do not – and never will – know exactly what impact QE has had, since we do not know what would have happened without it. Nonetheless, we can observe what happened at the time that changes to QE were announced and thus make a reasonably good guess. As far as the first channel goes, the impact appears to have been negligible. Bank lending to firms and households is at the same level as when QE began.
Yet QE does seem to be having at least some positive impact through the other two channels. Gilt yields fell when QE was first announced and again when it was extended. And yields have tended to rise whenever MPC members have suggested that QE might be coming to an end. Depending upon maturity, compared with where they would otherwise have been, QE has probably taken between 30 and 100 basis points off gilt yields.
Meanwhile, equity prices have risen by 45pc since QE began, [though others maikntain that this is, in fact, a dangerous unsupported asset bubble! -cs] and commercial property prices have recently edged up. Moreover, spreads on five- and 10-year A-rated corporate bonds are down by over 100 basis points. And the issuance of corporate bonds and equities rose sharply over the summer, although it has slipped back in the past month or two.
Isn't QE storing up an inflationary problem? Some more excitable commentators brand the policy as wholly irresponsible, associating it with Zimbabwe or the Weimar Republic, and talking of wheelbarrows of money. This is where use of the "printing money" term and a lack of familiarity with, or a loss of memory with regard to, Sayers and Keynes can readily lead to exaggeration and hyperbole.
I don't deny that the policy of QE carries an inflationary risk. As and when the economy recovers, if the present level of liquidity is left in the system then inflation would in due course pick up. But this risk can be averted – and there are bigger, more immediate risks. QE can only create inflation by first boosting nominal demand. Even then, the recovery needs to get close to exhausting the spare capacity in the economy before the inflationary danger lights up. Given that so far QE isn't even having much impact on demand, we're barely past first base.
What's more, QE can be quickly reversed if necessary. The most obvious way – selling back the purchased assets to the markets – would risk pushing bond prices down sharply. The realisation that this might inhibit the authorities is one reason why the critics suspect that QE will be reversed too slowly. But there are other ways to withdraw the liquidity. These include requiring banks to hold more reserves with the central bank (preventing them from using the reserves to lend more), selling Bank of England bills or raising interest rates.
In the end, the way out of our current dire predicament will depend hugely upon what happens to the world economy, over which we have no control and precious little influence. We have done all we can to help our export response to whatever transpires by allowing and encouraging the pound to fall.
As far as things over which we have control are concerned, all we have is QE. It is without doubt a dangerous policy. The far bigger danger, though, would be to do nothing, allowing the recession to continue and the economy to sink into deflation.
This week the MPC should announce more QE – and it should be prepared to do even more if necessary. It should not stop until economic recovery is well established and can reliably withstand the coming fiscal tightening. That looks like being some way into the future.
------------------------------------------------------------
Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte. His new book, "The Trouble with Markets", has just been published by Nicholas Brealey
Posts
