The following is an abbreviated version of a post from Credit Writedowns Pro from 7 Nov 2014
I caught a chart from a Martin Wolf missive that I thought was quite astonishing.
This chart shows central bank assets relative to economic output making an absolutely hockey stick-style increase in Japan in the wake of Abenomics. I don’t know yet what exactly to make of this chart but I want to use this column to work out some of my thinking associated with it. My hope is to use this as fodder for a segment I want to do on the TV show I produce.
The Martin Wolf message was as follows:
So what lessons should others, particularly the European Central Bank, learn from Japan’s predicament? The answer is: do not start from there.
The Japanese are where they are for three reasons. First, the Bank of Japan pursued too tight a monetary policy, especially in the early 1990s, to punish the sins of the bubble economy. Second, the government added too rapid a tightening of fiscal policy in 1997. Finally, the Japanese never dealt with structural excess savings in the corporate sector. These mistakes entrenched the disinflationary pressure that the BoJ now seeks to end with its desperate expedients.
All this has strong echoes today in the eurozone. Not least, the dominant attitudes are needlessly punitive. The eurozone has also been unwilling to address the structural excess savings of creditor countries. Yet what the eurozone should remember is that, regardless of economic outcomes, Japan will remain a functioning country with an utterly loyal citizenry. The eurozone does not possess such powerful advantages. It cannot even risk falling into anything close to Japanese deflation. But it is.
I think that’s largely right at the macro level. But I am a bit more fatalistic here. First, I don’t think the Bank of Japan’s tight money was the problem. Second, while the fiscal tightening in 1997 dealt a fatal blow to the economy, I also believe demographics and high private debt made the debt deflationary outcome almost inevitable in Japan. So the structural problems of note are less the excess savings in the corporate sector today, and more the excess debt in the corporate sector when secular stagnation first began in the 1990s.
The right approach to Japan’s woes were more about fixing corporate balance sheets quickly than they were about fiscal, monetary or excess savings fixes. Analogously, in the US and Europe, where wages have been stagnant or receding, it’s going to be just as hard to have an enduring recovery given the private debt problem resides on household balance sheets. Fixing household balance sheets is the order of the day.
And I think this goes back to the chart that started my part here on Japan. The central bank has created yen and swapped this base money with existing financial assets, bloating its balance sheet as some sort of fundamental move to jump start the economy. The goal seems to be to increase inflation by any means necessary because deflation is ‘bad’.
The problem with this approach is that it doesn’t lead anywhere. What people want in any economy is money and financial assets that they can exchange for real economic resources in the present and future. We want the means to receive a stream of goods and services that we value. And that’s pretty much it. For the most part, the other stuff is irrelevant.
Think of it this way. I work for a living, meaning I work in exchange for monetary compensation that allows me to buy goods and services that I value. My expectation is that, if I work hard, the stream of goods and services I can expect to receive over time will be as good or better than the stream I have received in the past. And when I stop working, I expect to be able to enjoy a stream of goods and services that, though diminished, is as good or better than what my parents received when they stopped working. We’re talking about food, clothing, housing, entertainment, vacation, drugs, healthcare, and education plus a lot more.
If wages in Japan are stagnant, how is increasing inflation going to help wage earners afford a better stream of good and services? It won’t. And of course, that gets us to the corporate savings issue, where I don’t have a response in the context of today’s policy choices. Right now, at least in the US and Europe, people are talking about lower corporate taxes, which ostensibly means greater savings net of investment. How lower taxes lead to lower corporate savings and more investment, I don’t know. But, again, none of this increases the stream of goods and services I can reasonably expect to obtain.
I don’t have any answers here in the context of the current policy choices being debated. Currency devaluation is beggar thy neighbor in a zero sum game of trade and not a lasting solution. It might be a jump-start, but it is nothing more. Ultimately, what we need to see are policies which maintain wages for median and lower-income wage earners with the greatest marginal propensity to spend. Without this, in a demographically challenged and indebted private sector, so-called secular stagnation is almost a certainty.