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Japan’s prime minister threatens to unify monetary and fiscal policy

Greetings to you all on Christmas Eve. I think the big deal today is not America or Europe, but Japan. The incoming Japanese Prime Minister is threatening to strip the Bank of Japan, the central bank, of its independence. What Mr. Abe said is that the Bank of Japan needs to set at least a 2% inflation target. And he went further, saying that if they do not, he would “revise the Bank of Japan law and set” the 2% target himself. This is serious stuff. And Abe won the election in a landslide. So he can do this, there is no doubt.

Like a lot of macro analysts, I look to Japan now because they are at the forefront of the debt deflationary revolution we have entered at this end of a debt super cycle. They got to peak debt first. Japan resorted to zero rates first. And these zero rates turned into a permanent policy first – what I call “permanent zero.” Japan also was first to run massive budget deficits to ease the pain of deleveraging, rather than let the economy collapse. And the Japanese were also first to run into a lack of political policy space for their deficit policies, something we have seen in euroland, the UK and are now seeing in the US. Likewise, Japan is first in threatening to strip the central bank of its independence so that it can run an easier monetary policy. We’re not talking about political oversight a la Ron Paul to keep the central bank from printing money, just the opposite.

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The best case scenario here is the UK post-World War 2 scenario that I like to use as the model case for countries trying to inflate away systemic debt supercycle problems. See here on UK National debt since 1922. The UK was able to work down its government debt burden through currency depreciation and inflation. The result was not benign; we saw a crumbling infrastructure and the British falling behind countries like Germany and Switzerland and even France and Italy on a per capita GDP level. Only through financialization of the economy has Britain been able to make up some of the lost ground. This is a best case scenario. So there are no good answers here. When debt builds up like this, the result is economic malaise.

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My guess here is that the Yen will depreciate in 2013 because the political winds are blowing toward an aggressive monetary policy to support a depreciation. And this will help the Japanese economy. But yields will remain low and deflation will still be a threat. In my view, there is nothing that suggests we are on the cusp of a Japanese meltdown, something macro analysts have predicted every year for the last twenty. If policy does change substantially where this becomes a possibility, I will change my tune.

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Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.