October 2023 Monthly: Prepare for the biggest economic crisis in Japan since the war!

 

October 2023 Monthly: Prepare for the biggest economic crisis in Japan since the war!

Common sense in Japan is nonsense in the world, and common sense in the world is nonsense in Japan.

 

October 23, 2023

 

 

Professor Rogoff, author of the famous book “Nations Will Bankrupt,'' warns of Japan's financial crisis!

 

(Nakamaru) Professor Rogoff of Harvard University's School of Economics is one of the world's leading experts on international finance, but as if to resist (resist) the recent trend of rising global inflation and rising interest rates, he has announced negative interest rates. Project Syndicate and other publications began warning on October 5th that a financial crisis could occur sooner or later in the Japanese economy, which refuses to stop its unprecedented level of monetary easing.

 

What does Bing think about the possibility of a recurrence of Japan's financial crisis?

 

Also, is Professor Rogoff's theory that Japan's financial crisis is reignited a minority?

 

 

(Bing) Regarding the possibility of a recurrence of Japan's financial crisis, Professor Rogoff said the following in an interview with the Nihon Keizai Shimbun.

“Japan is one of the most highly indebted countries in the world in the long run. In order to support that debt, it is necessary to continue unconventional monetary policies such as negative interest rates and quantitative and qualitative easing. Yes, but it's not sustainable. Eventually Japan will have to raise interest rates, and that's when the debt problem will come to the fore."

Professor Rogoff also points out that Japan faces structural issues such as aging and population decline. He also says that Japan is paying the cost of a weaker yen and lower real wages to become more competitive with China and other Asian countries.

Professor Rogoff's theory of a recurrence of Japan's financial crisis is not in the minority. Indeed, institutions such as the International Monetary Fund (IMF) and the European Central Bank (ECB) have also expressed concern about Japan's fiscal situation and monetary policy. However, the Japanese government and the Bank of Japan maintain that current monetary policy is appropriate and that they are working toward inflation targeting and fiscal consolidation.

 

(Nakamaru) Why are the IMF and ECB expressing concern about Japan?

 

(Bing) There are three main reasons why the IMF and ECB have expressed concerns about Japan's fiscal situation and monetary policy.

• Japan's public debt is the highest in the world as a percentage of GDP, and is rising further due to massive government spending to combat the pandemic. This could raise issues of debt sustainability and fiscal buffers.

• Japan has continued unconventional monetary policies such as negative interest rates and quantitative and qualitative easing for a long time, and there is uncertainty about their effects and side effects. A change in monetary policy or a rise in interest rates could cause turmoil in domestic and international financial markets.

• Japan faces structural problems such as aging and population decline, and labor market and fiscal reforms are needed to increase its potential growth rate. Responding to climate change and digitalization are also important issues.

 

(Nakamaru) In any case, the points that caught my attention the most in Rogoff's warning of the Japanese financial crisis are as follows.

 

“Given that Japan's total government debt currently stands at 260% of GDP, or 235% of GDP after deducting foreign exchange reserves of $1.25 trillion, the Bank of Japan is reluctant to raise short-term policy rates. This is understandable. If the central bank were forced to raise its short-term policy rate by 3% (about half that of the US Federal Reserve), the cost of servicing the government's debt would increase exponentially."

 

And, "Policies to stem the decline would only advance the need for interest rate normalization. The most severe financial crises often occur in unexpected places. Japan's resurgence is good for the global economy." However, a resurgence in Japanese interest rates could pose a major risk."

 

 

Aggregate demand suppression policy is common knowledge around the world to address the inflation gap (aggregate demand > aggregate supply)

 

(Nakamaru) Despite the fact that the Japanese government (Cabinet Office) admits that there is already a positive output gap (inflation gap) in which aggregate demand exceeds aggregate supply, monetary and fiscal policies are not designed to stimulate aggregate demand. Isn't Japan's macroeconomic policy at risk of being ridiculed as unreasonable in the world?

 

(Bard) Yes, I think that's right. A situation in which aggregate demand exceeds aggregate supply can lead to inflation. As of October 2023, Japan's consumer price index (CPI) has increased by 2.9% from the previous year, far exceeding the 2% price target. Under such circumstances, implementing policies to stimulate aggregate demand through both monetary and fiscal policy may further accelerate inflation and may be criticized as unreasonable in the world.

Specifically, the following points may be criticized:

• By keeping interest rates low, monetary policy has the effect of lowering financing costs for businesses and households and promoting investment and consumption. However, in a situation where aggregate demand exceeds aggregate supply, keeping interest rates low may further accelerate inflation.

• Fiscal policy has the effect of directly increasing aggregate demand by increasing spending on things like public works and social security. However, if aggregate demand exceeds aggregate supply, the fiscal deficit may expand and fiscal sustainability may be undermined.

Furthermore, Japan is already one of the world's leading deficit countries, with a budget deficit (more precisely, government debt) exceeding 250% of GDP. Under such circumstances, implementing policies that further increase the fiscal deficit may be criticized by the international community.

Of course, Japan's macroeconomic policy has the clear goal of overcoming deflation and improving its growth potential. However, it is necessary to be fully aware that policies that stimulate aggregate demand carry the risk of accelerating inflation and widening the fiscal deficit, and to implement them carefully.

 

 

It is common knowledge around the world to respond to rising prices by raising interest rates, not by fiscal policy.

 

(Nakamaru) Isn't it common sense in the world to respond with fiscal policies such as tax cuts instead of trying to normalize monetary policy such as raising policy interest rates as a measure against soaring prices?

 

(Bard) Yes, I think that's right. In response to soaring prices, it is common to normalize monetary policy (raise the policy interest rate). Normalizing monetary policy has the effect of raising interest rates, increasing financing costs for businesses and households, and suppressing investment and consumption. This helps reduce aggregate demand and curb inflation.

 

On the other hand, fiscal policy has the effect of directly increasing aggregate demand by increasing spending on public works projects, social security, etc. However, responding to soaring prices with fiscal policy could increase aggregate demand and further accelerate inflation.

 

The Japanese government has actively utilized fiscal policy to overcome deflation and improve growth potential. However, as of 2023, Japan's budget deficit (more precisely, the outstanding national debt) has already exceeded 250% of GDP, and there is a growing risk that fiscal sustainability will be undermined.

 

Under such circumstances, the use of fiscal policy as a countermeasure against soaring prices may be criticized as worldly nonsense.

 

Of course, fiscal policy can also be considered to have an effect on suppressing inflation. For example, tax cuts have the effect of promoting consumption by increasing household income. However, tax cuts must be implemented carefully as they carry the risk of expanding the budget deficit.

 

The Japanese government will need to strike a balance between normalizing monetary policy and fiscal policy as a countermeasure against soaring prices.

 

The virtuous cycle of wages and prices is a global nonsense

 

(Nakamaru) In Europe and America, it is common sense to be concerned about the vicious cycle between wages and prices.

 

In Japan, on the other hand, policies to stimulate aggregate demand are being continued under the guise of aiming for a virtuous cycle between wages and prices.

 

Isn't this a common sense in the world?

 

(Bard) Yes, I think that's right. In Europe and the United States, a vicious cycle between wages and prices is said to pose a risk of increasing inflation rates and inhibiting economic growth.

 

Therefore, in order to prevent a vicious cycle between wages and prices, measures such as monetary policy tightening and fiscal policy spending cuts are taken.

 

On the other hand, in Japan, a virtuous cycle between wages and prices is said to lead to overcoming deflation and improving growth potential. For this reason, policies are being advanced in the direction of continuing aggregate demand stimulation policies and promoting increases in wages and prices.

 

However, Japan's policy to stimulate aggregate demand can be said to be extremely risky from the perspective of Western common sense.

 

First, Japan's labor market has a structural problem in that workers have weaker bargaining power than in Europe and the United States, meaning that increases in wages tend to lead to increases in prices. Therefore, if a virtuous cycle of wages and prices were to materialize, the inflation rate would rise sharply, potentially causing major disruption to the economy.

 

Furthermore, Japan's financial situation is extremely difficult compared to Europe and the United States. Therefore, if policies to stimulate aggregate demand are continued, the fiscal deficit may widen further and fiscal sustainability may be undermined.

 

Of course, the Japanese government is also taking measures to prevent a vicious cycle of wages and prices. For example, in order to curb wage increases, we are moving forward with labor market reforms, such as freezing (actually delaying) increases in the minimum wage.

 

Furthermore, efforts are being made to reduce spending and increase tax revenue in order to control the budget deficit.

 

However, it is still unclear whether these measures will be fully effective. Therefore, the Japanese government will need to make careful decisions when continuing with policies to stimulate aggregate demand.

 

The following is a summary of the reasons why Japan's aggregate demand stimulus policy may be criticized as unreasonable in the world.

• Due to problems with Japan's labor market structure, there is a risk that the inflation rate will rise sharply if a virtuous cycle of wages and prices is achieved.

• Given Japan's difficult fiscal situation, there is a risk that the fiscal deficit will widen further if policies to stimulate aggregate demand are continued.

• In Europe and the US, it is common to take measures to prevent a vicious cycle between wages and prices.

The Japanese government needs to be fully aware of these risks and carefully implement policies to stimulate aggregate demand.

 

A hard landing for the Japanese economy is inevitable

 

(Nakamaru) In the United States, the inflation rate is approximately 4% as of October 2023, while the Fed's policy interest rate has been raised to 5.5%, and the real policy interest rate is turning positive.

 

On the other hand, in Japan, the inflation rate is 3-4%, but the Bank of Japan's policy interest rate is -0.1%, meaning the real interest rate remains at a significantly negative level.

 

Therefore, in the United States, there is a possibility of a soft landing with sustained growth under stable prices, but in Japan, as inflation accelerates and asset bubbles in stocks, real estate, foreign exchange, etc. are amplified, there is a possibility of a hard landing. I guess we can't deny it.

 

In fact, in October, Professor Rogoff of Harvard University's School of Economics (former IMF chief economist), one of the leading experts on international finance, began warning in the Project Syndicate newspaper about the possibility of a financial crisis in Japan.

 

(Bard) Yes, I think that's right. There is a large difference in policy interest rates between the United States and Japan, and it cannot be denied that this difference poses risks to the Japanese economy.

 

In the United States, monetary tightening by the Federal Reserve has the potential to suppress inflation and sustain economic growth. This is a condition called a soft landing.

 

On the other hand, in Japan, if the Bank of Japan continues to implement monetary easing, the inflation rate may rise further. Furthermore, the continued depreciation of the yen and the rise in import prices will increase the burden on businesses and households, potentially slowing economic growth. This is a condition called a hard landing.

 

Professor Rogoff's warning suggests that the Japanese government and the Bank of Japan need to be fully aware of these risks and carefully manage policy.

 

Below is a summary of the risks posed by the difference in policy interest rates between the United States and Japan.

• US: Possibility of soft landing

• Japan: Possibility of hard landing

 

The Japanese government and the Bank of Japan need to be fully aware of these risks and consider policy management.

Specifically, the following measures can be considered.

• Japanese government: aims to cut spending and increase tax revenue to curb the expansion of the fiscal deficit.

• Bank of Japan: Gradually increase the pace of monetary easing (actually promote financial normalization) to curb the rise in inflation.

By taking these measures, Japan's economy will have a better chance of avoiding a hard landing and achieving sustainable growth.

 

Will the Reiwa bubble surpass the Heisei bubble?

 

Even if this is not the case, it is a well-known fact that the outstanding government debt (national bonds) is more than twice the size of the Japanese economy (nominal GDP level), and that the Bank of Japan continues to hold government bonds to a level that far exceeds GDP. .

 

It is feared that sooner or later, the Japanese economy will be forced to face the biggest economic crisis since the war. In particular, amidst inflation and rising interest rates, it is inevitable that households will suffer the most from high inflation taxes and rising interest rates.

 

The common wisdom in global economics for stabilizing inflation is that, amid rising inflation, the policy interest rate will eventually be raised to a level that exceeds the inflation rate, and the real policy interest rate will turn from the current significantly negative value to positive. This is where I teach you.

 

Initially, the Federal Reserve misdiagnosed the rise in inflation that began in the spring of 2021 as temporary, and was far behind in eliminating inflation. However, by the summer of the same year, it had graciously acknowledged that it had misunderstood persistent inflation.

There has been a series of significant interest rate hikes.

 

Currently, the US policy interest rate level has been raised to 5.5% on the assumption that prices will rise by about 4%, and the Fed's real policy interest rate level has been maintained at a positive rate of about 1.5%. Although it is still difficult to predict, this is the background behind the recent trend of the US inflation rate in 2023 (day inflation).

 

 

Bank of Japan Ueda is busy moving the goalposts of the 2% price stability target policy

 

We cannot help but see that the 2% price stability target policy, which the Bank of Japan had promised the people for over 10 years, is clearly about to be reneged on even with the new Bank of Japan Governor Ueda in place. plug.

 

For example, in FY2022, the core CPI excluding fresh food, which has been the Bank of Japan's inflation target indicator, has already recorded 3.0% compared to the previous year.

 

In the current fiscal year 2023, the core CPI index has consistently increased by +3% until August.

 

Moreover, if we add back the price-depressing effect of the Ministry of Economy, Trade and Industry (government) subsidy to businesses such as electricity and gas rates that has been implemented since February 2023 by about 1 percentage point, the true core CPI will be It is clear that the rate of increase is in the 4% range.

 

If things continue as they are, the Bank of Japan will work with the government to break its promise to the people by insisting that the 2% price stability target is not stable, sustainable, or trend-setting for two years, from FY2022 to FY2023. Is it really acceptable in a democracy or market capitalism to repeatedly impose heavy inflationary taxes?

 

 

Ueda Bank of Japan has no chance of winning

 

In any case, it does not seem like the Bank of Japan Ueda has the slightest chance of success in achieving price stability and sustainable growth.

 

Real wages in August, excluding the effects of price fluctuations, were below the previous year's level for the 17th consecutive month, and although the decline was smaller from the previous month, it was larger than market expectations. Although we achieved wage increases and nominal wages continued to increase, wage growth has not been able to keep up with rising prices for the past 17 months.

 

With the current combination of fiscal and monetary policies by the government and the Bank of Japan, it will not be possible to permanently increase real wages.

I have already mentioned the risk of falling into a vicious cycle of wages and prices rather than a virtuous cycle, but let's take a closer look at the mechanism below.

 

In economics, the unemployment rate at which the labor market is in equilibrium with supply and demand is called the natural unemployment rate or the unemployment rate that does not accelerate inflation (NAIRU). However, it is not easy to determine them theoretically and numerically.

 

Therefore, the first step is to focus on past trends in the unemployment rate, which is basic data in the labor market.

 

As the table below shows, Japan's unemployment rate of 2.8% as of August has been on a slight upward trend recently, but it is still extremely low from a historical perspective, clearly indicating a tight labor market. You can say that.

 

Assuming that the unemployment rate since 1970 is 3.2%, which is extremely low from a historical perspective (therefore, assuming an extremely tight labor market), the Taylor rule, styled by US Treasury Secretary Yellen, is based on the unemployment rate rather than the output gap. If we calculate the policy interest rate that should be as shown in the diagram below, we have to say that there is a great possibility that the Ueda Bank of Japan will be forced to raise interest rates rapidly and significantly due to rising inflation.

 

 

The mystery of "Bank of Japan purchases 70.1 billion yen in ETFs for the first time in 7 months"

 

By the way, according to a Reuters article, on October 4th (Wednesday), the Bank of Japan purchased 70.1 billion yen in ordinary ETFs (exchange traded funds) on the Tokyo stock market. The Bank of Japan's ETF purchases are the first in about seven months and the third time this year since March 14th.

 

However, this was the first ETF purchase since April, when Governor Kazuo Ueda took office. This is probably due to the fact that 4 days ago, TOPIX was down 2.01% from the previous business day to 2,229.76 points.

 

However, BOJ Governor Ueda must have clearly pointed out that the BOJ's purchases of Japanese stocks (ETFs) are a major problem both before and after he took office in April.

 

In any case, there will be no disagreement between words and deeds. At the very least, the governor will be required to provide accountability at a press conference after the next monetary policy meeting on October 31st.

 

 

The crime of a Yomiuri editorial that recommends risk-loving asset management as the financial crisis approaches

 

Coincidentally, the Yomiuri Shimbun published an article on October 22nd. The editorial was titled ``Strengthening asset management so that many people can benefit.''

 

``Asset management is becoming increasingly important in securing funds for retirement. We would like to advance reform of asset management companies and pension funds so that many people can benefit from them.'' Of the approximately 2,100 trillion yen, cash and deposits account for the majority. It is said that it is approximately 30% in Europe and approximately 10% in the United States, and Japan's cash and deposits account for an outstandingly high proportion.  As a result, It has been pointed out that the people's asset accumulation is lagging behind.'' He added, ``Asset management is becoming increasingly important in securing funds for retirement.'' I want to make sure that many people benefit from this," he said.

 

However, the Bank of Japan owns a large amount of Japanese stocks and Japanese government bonds. There are asset management institutions in Japan centered on GPIF that hold large amounts of these assets.

 

In addition, we cannot deny the risk that the Japanese yen, which deviates significantly from long-term purchasing power parity, will destabilize the value of foreign financial assets in the Japanese currency over the long term.

 

The Japanese people are exposed to great risks from asset management institutions that hold large amounts of these domestic and foreign risk assets.

 

Due to the dramatic changes in the world economy and international financial markets, there is a possibility that the complacency in the financial markets that has recently developed this summer will turn into panic, as was seen in the sharp rise in the fear index (VIX) last week. .

 

In particular, amid concerns about persistently high inflation in the world economy and international financial markets and the risk of rising interest rates, the government insists on continuing negative policy interest rates and unconventional monetary easing, as if going against the global trend. We cannot help but think that the risks in Japan's financial market, centered on the Bank of Japan, are quite large.

 

In addition, the Kishida administration has made no attempt to stop the massive expansion of fiscal spending.

 

The asset management environment due to the overheating of the Japanese economy and the amplification of asset bubbles may not only be a disaster for risk lovers, but also a disaster for people who should be risk-averse.

 

In these senses, the company's theory is too brave and cannot escape being criticized as reckless.

 

 

Japanese leaders who repeatedly fail

 

Why does our country keep making mistakes?

 

First, there is a lack of analytical ability among Japanese people. There is a particularly large lack of analytical ability in the "leader" level.

 

For this reason, Japan is unable to set clear (economic) strategic goals.

For example, in the famous book ``The Essence of Failure'' (Chukou Bunko), which explains the essence of the Japanese military's failures in the Greater East Asia War, it states, ``The critical point that differentiated the success of the U.S. military from the failure of the Japanese military was... When an unforeseen situation arose, the question was whether we were able to respond instantly, effectively and appropriately."

 

The same book also states, ``The question is how did they fare in a crisis?'' The Japanese military had ``ambiguous operational objectives,'' ``self-righteousness in the reception and interpretation of information,'' and ``excessive actions in combat.'' In other words, the Japanese military during the Greater East Asia War lacked scientific and objective analytical ability.

 

Japan does not have a concrete, quantified long-term strategy to overcome its current biggest enemy, inflation, and achieve sustainable growth. Furthermore, there are no policy instruments that are consistent with long-term strategies. As a result, no matter how long it takes, sustained economic growth without inflation will not be achieved.

 

Just like the former Japanese army, without a clear strategy and tactics, without taking advantage of the lessons from past defeats, we will repeatedly "introduce troops one after another" and waste our nation's "troops" and resources needlessly. It looks like it is.

 

In the end, our country is still unable to take a scientific and objective view. In particular, there is a lack of a correct understanding of economics and the ability to accurately apply economics. Therefore, it is difficult to draw up a grand design for reviving the Japanese economy.

 

There are frightening similarities between the former Japanese military of 80 years ago and the Reiwa government, Ministry of Finance, and Bank of Japan that are commanding the current "economic war."

 

Unfortunately, this may be in the DNA of Japanese leadership.

 

 

 

Former World Bank Economist

Tomo Nakamaru