Sunday, December 14, 2014

Japan’s Lemmings March Toward The Cliff Chanting “Abenomics”

By David Stockman

According to Takahiro Mitani, trashing your currency, destroying your bond market and gutting the real wages of domestic citizens is a sure fire ticket to economic success. Yes, that’s what the man says,
“I have no doubt that the economy is in a recovery trend if you look at the long run….”
After two years of hoopla and running the BOJ’s printing presses red hot, however, there is not a shred of evidence that Abenomics will lead to any such thing. In fact, after the recent markdown of Q3 GDP even deeper into negative territory, Japan’s real GDP is no higher now than it was the day
Abenomics was launched in early 2013; and, in fact, is no higherthan it was on the eve of the global financial crisis way back in 2007.

Historical Data Chart

In the meanwhile, the Yen has lost 40% of its value and teeters on the brink of an uncontrolled free fall. Currency depreciation, of course, is supposedly the heart of the primitive Keynesian cure on which Abenomics is predicated, but there is no evidence or honest economic logic to support the proposition that—–over any reasonable period of time—–a nation can become richer by making its people poorer.

Historical Data Chart
That’s especially true in the case at hand, which is to say, a Pacific archipelago of barren rocks. Japan imports virtually 100% of every BTU and every ton of metals and other raw materials consumed by its advanced $5 trillion industrial economy.

Yet thanks to the mad money printer who Prime Minister Abe seconded to the BOJ, Hiroki Kuroda, import prices are up by a staggering 30% since 2012. Even with oil prices now collapsing, the yen price of crude oil imports is still higher than it was two years back. Not surprisingly, input costs for Japan’s legions of small businesses have soared, and the cost of living faced by its legendary salary men has risen far faster than wages.

Historical Data Chart
Accordingly, domestic businesses that supply the home market—and that is the overwhelming share of Japan’s output—are being driven to the wall, bankruptcies are at record highs and the real incomes of Japan’s households have now shrunk for 16 consecutive months and are down by 6% compared to 2 years ago. And the purpose of all this punishment?

Well, its something right out of the Keynesian “Sesame Street”. We are talking here about our friend the letter “J” that was scribbled on a napkin in Cambridge MA more than a half-century ago. That is to say, when you trash your currency your trade balance is supposed to get worse for a while, and then it gets all better. Hence, the “J-curve”.

Needless to say, its not working for Japan. The fact is, Japan is an old age colony that is in debt up to the eyeballs of what will soon be  a retirement population larger than its work force. So it desperately needs to run a trade balance—and better still, a surplus—-with the rest of the world in order to accumulate acorns for its long time future as an economic rest home.

As shown below, however, Abenomics has had the very opposite effect. Japan’s normal moderate surplus since its 1990 crisis has plunged into deep red ink since the onset of Abenomics. Stated differently, Seasame Street economics has been an unmitigated disaster for Japan.

Historical Data Chart

The idea of the J-Curve and getting richer by getting poorer is nonsense anyway. But when you apply this misbegotten Keynesian dogma to a unique economy that is essentially a one-of-a-kind materials conversion machine, which transforms raw resources from the rest of the planet into advanced industrial, consumer and technology goods, you are essentially committing economic hari kari.

Even before taking into account the potential for trade and currency retaliation owing to this blatant beggar-the-neighbor policy, Japan will never get off the bottom of its J-Curve because is inherently a big importer. And unlike Germany, for example, where exports amount  to 40% of GDP, Japan’s exports now average less than 12%.

So in terms of the Keynesian preoccupation with “flow” (that is, current period income and outgo), here is what you have on the trade front. Exports have risen barely 18% in yen terms and not at all in physical quantity. By contrast, imports are up 35% in yen terms—-not because Japan Inc is thriving, but because the BOJ has flooded the world with yen that nobody wants.

Historical Data Chart
Historical Data Chart

But the “nobody wants” part is the heart of the matter. Keynesian economic models have no balance sheet concept, and therefore its high priests roam the world preaching the same one-size-saves-all dogma to governmental congregations, whether they are flush with cash or are buried in debt. But that is just plain stupid when it comes to today’s monumental debtors.

The latter desperately need to reduce their consumption and increase their savings—–especially if they are rapidly getting old demographically and need to build their individual and collective nest eggs. Needless to say, the BOJ’s vicious assault on savers makes the Fed look like a model of decorum.

Forget the overnight rate, which is ZIRP on most of the planet. In Japan, 10-year money on the supposed risk-free JGB is now exactly 0.398%.Consequently, there is not a single sentient buyer for Japan’s monumental government debt left anywhere in the known universe. Germans and Martians, who count their wealth in something other than yen, are most certainly not going to buy bonds denominated in a vanishing exchange rate.

The same story holds domestically. The long suffering Japanese banks are getting out of government bonds, and not just because the MOF and BOJ are telling them to. Indeed, along with the life insurance companies, other institutional investors and even the proverbial Mrs. Watanabe of the household sector, they are getting out of JGBs because Kuroda and Abe are making them a proposition they can’t refuse. Namely, these madmen through the open market desk at the BOJ are “bid” any and all bonds on offer; and at nose-bleed prices (that is, the inverse of the 0.398% yield) that vastly exceed the true economic value of debt that one day the Japanese government must and will default on.

In other words, blindly following the Keynesian dogma that has been impressed upon them by the IMF economists, the G-7 and G-20 apparatchiks, and the parade of itinerant snake oil salesman like Krugman, Bernanke, and Larry Summers, the BOJ has become some kind of infernal vacuum cleaner that intends to suck-up every last bond the bankrupt Japanese government can issue. And as a reminder, that is  already a financial Mt. Fuji and then some.

Historical Data Chart

Needless to say, bidding the entire world out of its JGBs creates two gargantuan problems. In the case of domestic investors, what do they do with the cash? Well, in the paradigm of Keynesian central bankers the world over—they, perforce, put it in “risk assets”.

And that brings us back to Mr.Takahiro Mitani——the man with utmost confidence that Japan’s economic future is bright and the nominal head of Japan’s giant $1.4 trillion Government Pension Investment Fund (GPIF). But let’s state that more plainly. Mitani is the utterly naïve and clueless long-time BOJ-GPIF financial bureaucrat who has been ordered by Abe to flush the GPIF of upwards of $400 billion of government bonds which it has held for years, and upon which it has earned virtually nothing, in favor of buying the Japanese stock market and a global equity basket, too.

Stated differently, these Keynesian preachers like Summers and Krugman, who have the government of Japan in their thrall, are downright cruel and malevolent. One of the few things that can keep Japan’s projected 35 million retirees from resort to cat food someday is their $1.4 trillion GPIF nest egg.

But under the influence of these financial terrorists—–and there is no other way to describe them—– the government of Japan has ordered that a huge chunk of that nest egg be put four-square in harm’s way. That is, be invested at the tippy top of the greatest stock market bubble the world has every seen.
Upwards of 40% of the fund is to go into equities and other alternative assets and two-thirds of that is earmarked for Japanese equities. So it is no wonder Mr. Mitani is whistling a happy tune about Abenomics. He has no choice. After all, he has been “invited” to put hundreds of billions into the Japanese stock market after it has doubled in response to an economic program that amounts to a suicide mission.

Japan Stock Market (NIKKEI 225)

This is where Keynesian dogma has taken Japan—–it has turned its vaunted elite bureaucracy and historic governing class into a pathetic band of financial lemmings. In particular, the GPIF desperately needs to earn a robust return now before the real demographic tsunami hits.  That is, before its current 80 million strong work force shrinks to just 40 million over the next 50 years, while its army of retirees swells from 25% to more than 40% of its population over the period.

But its central bank is now all-in for Keynesian money printing ,and has thereby vaporized any yield at all in the fixed income market; and has also knowingly or not, invited all the fast money punters of Wall Street, London and the rest of the world to front-run an insane Tokyo stock market bubble—–confident that at the first sign of trouble they can drop their inflated shares on the retirement population of Japan.
Calling that scenario a reverse Pearl Harbor would be only a mild resort to metaphor. Yet “Pearl Harbor” is the right metaphor because it is forever connected with the brutal war which raged across the length and breadth of East Asia thereafter.

This time it will be a currency war, but no less devastating for all parties involved. The yen FX rate is currently in a temporary holding pattern around 120, but just wait for the up-coming snap election and the likelihood that the Japanese people will follow its lemming leaders toward the terrible cliff of Abenomics.

But upon news of Prime Minister Abe’s electoral “mandate” to plow full stream ahead, the Yen could plunge through 120 in an instant, and be well on its way to 140 and not so far down the road to 200. But as George H.W Bush said in another context—- and not the one which brought him to the feet of Prime Minister Miyazawa in 1992—–the upcoming cliff dive of the Japanese yen “cannot stand”. It will amount to a thundering frontal assault on the export mercantilism on which the entire bloated edifice of China and the rest of East Asia is built.

One thing is certain about the ensuing “race to the bottom”. Japan’s retirement colony will end up with the hindmost.

And they will surely burn professors Krugman and Summers in effigy—-even if driftwood is the only fuel they have left.

 David Stockman was the Director of the Office of Management and Budget during part of the Reagan Administration, from 1981 to 1985. He is the author of The Great Deformation: The Corruption of Capitaism in America and The Triumph of Politics: Why the Reagan Revolution Failed.

 The above originally appeared at David Stockman's Contra Corner and is reprinted with permission. 

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