Walter Hamilton. Calling up the reserves.

Nov 2, 2014

Japan’s central bank, 18 months into a monetary stimulus strategy of unprecedented scale, has decided to dramatically raise the bet. Since an extra 60 trillion yen annually fed into the economy failed to do the trick, perhaps 80 trillion (A$800 billion) will work. The look on the face of central bank chief Haruhiko Kuroda when making the announcement resembled that of a World War I general who having spent 100,000 men to gain 100 yards sees no way forward except to spend another 100,000 for ‘total victory’.

The Japanese economy, says Kuroda, is at a tipping point. Again. The risk is it will slip back into a deflationary cycle and all his and the Abe Government’s efforts to restore growth and confidence will have come to nothing. The size of the stimulus expansion surprised the markets: stock prices leapt and the yen fell to its lowest level in six years. But will ‘shock and awe’ have the desired effect on Japanese consumers? They’ve seen and heard the big guns of monetary policy being fired so often in recent times, Kuroda must know he is captive to the law of diminishing returns. Significantly, the bank board voted only narrowly in favour of the extra stimulus, 5 to 4, the decision obviously hanging on Kuroda’s vote.

What has been gained so far by the much-touted Abe-nomics, the government’s money-printing strategy for recovery? The yen has declined in value, which has helped exporters increase their profits (from very low levels in investment terms), and some of this increased income has been passed on through wage increases. But, at the same time, domestic consumption remains anemic. The overall economy contracted by 1.7% in the June quarter and price growth is almost flat again (the central bank wants inflation running at 2% per annum). There was a bout of spending ahead of a consumption tax hike in April (the government had to do something to rein in its huge budget deficit), but it was followed by an equally large contraction once the tax rise took effect.

Here is the nub of the problem. Income growth in Japan has been so weak for the past 20 years, and confidence levels so low, what little money people have left after paying the mortgage and school fees and meals they choose to save rather than spend. Which is why another announcement made at the same time as the central bank unveiled Abe-nomics Mark II was equally remarkable.

A big drag on consumption is the increasing share of household expenditure accounted for by retirees: aging Japanese drawing on the national pension scheme. The pension scheme’s earnings have been woeful for many years, largely as a result of its conservative policy of salting away 60% of investments in low-yielding Japanese government bonds. The managers of the pension scheme on Friday announced that would be cutting by half the proportion of investments held in domestic bonds while greatly increasing exposure to foreign shares and bonds, in a bid to increase returns to retirees. Younger Japanese refuse to spend their pay packets; perhaps the greying generation will spend their pension increases––or so the thinking goes.

If this step had been taken unilaterally the withdrawal of support from the domestic bond market might have been highly disruption. However, the central bank’s simultaneous decision to increase its purchases of government paper offsets the pension fund’s move into more speculative investments. The sight of two supposedly independent agencies acting collaboratively in this way might seem sensible, at one level, but it also suggests that official Japan has staked everything on one horse in a marathon steeple chase. Most observers have probably judged this to be the case already: nobody seems to have an alternative strategy. But might one ask, if the central bank is printing more money to buy an investment the nation’s own pension fund is so bearish about, how can that work?

Kuroda and Abe could point to the example of the United States, where the economy is growing again nicely following a similar monetary transfusion (now being turned off). There are, however, differences between Japan’s economic problems and the American recession. Endemic deflation, rather than credit flight, lies at the heart of Japan’s malaise. It is linked to weak income growth, a decline in the working-age population and the vast accumulation of government debts from a series of fiscal pump-priming measures undertaken with little effect after Japan’s asset bubble burst in the 1990s. Ironically, one result of the latest moves will be to make certain assets, notably stocks, more attractive: benefiting a small minority, with no automatic flow-on benefits to the wider economy. Small and medium firms don’t raise money on the stock market; they rely on bank credit, and if their principal market is the domestic consumer, the commercial banks are unlikely to be moved simply by this latest arrow fired into the air from the bow of Shinzo Abe and his Liberal Democratic Party government.

Walter Hamilton reported from Japan for the ABC for 11 years.

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