Abenomics & Rooseveltian Resolve

The new Bank of Japan chief Haruhiko Kuroda today unveiled an aggressive new round of monetary easing, the latest step in the policy of recently-elected Japanese Prime Minister Shinzo Abe.

As part of a promise to do “whatever it takes” to return Japan to growth, Kuroda promised a level of quantitative easing unseen before in Japan, intended to discourage saving and encourage spending. Kuroda promised to print 50 trillion yen ($520bn; £350bn) per year.That is the equivalent of almost 10% of Japan’s annual gross domestic product, and over double the level of what the Federal Reserve is currently experimenting with.

Many are hailing this as an attempt to put into practice the advice of Ben Bernanke to Japan in the 1990s — what Bernanke called “Rooseveltian resolve“. In fact, Ben Bernanke has provided a practical as well as a theoretical template through the unconventional policies adopted in the last five years by the Federal Reserve. Although some economic commentators believe that Shinzo Abe was more interested in reviving Japanese mercantilism and drive exports through a cheap currency, it is fairly clear that even if that is Abe’s ultimate intent, Abe is certainly harnessing Bernankean monetary policies (as well as Keynesian fiscal stimulus policies) in that pursuit.

So, will Abe’s policies return Japan to growth, as Bernanke might have intended?

Well, this diagnostic pathway sees deflation as the great central ill. The rising value of a currency acts as a disincentive to economic action and the encouragement of hoarding, because economic participants may tend to offset projects and purchases to get a greater bang for their buck. (This, of course, would be the great problem with Bitcoin becoming the sole currency as its inherent deflationary nature encourages inactivity and not activity, but that is a topic for another day). During deflation, delayed projects and subdued consumer spending are reflected in weak or nonexistent growth. More expected inflation encourages businesses and individuals to consume and start projects rather than save. At least, that’s the theory.

In theory, there’s no difference between theory and practice. In practice, there is. So in practice, what other effects are at play here?

First of all, the Japanese in general (or a substantial and influential proportion of them) seem to really dislike inflation. Why? Well, since the initial housing and stocks bubble burst in the 1990s, they have become a nation of capital accumulators with a low private debt level. This is at least partially a demographic phenomenon. Older people tend to have a much higher net worth than younger people who have had less time to amass capital, and they need places to park it — places like government and corporate debt. This has driven Japanese interest rates to the lowest in the world:


The other side of the coin here is that this has made it very easy, almost inevitable, for the government to run massive budget deficits and run up huge levels of debt (which has to be rolled). Higher inflation would mean that those elderly creditors (who have up until now voted-in politicians who have kept the deflationary status quo) will very likely experience a negative real interest rate. Many may find this a painful experience, having grown used to deflation (which ensures a positive real interest rate even at a very low nominal interest rate, as has been the case in Japan since the 1990s):


Every time Japan’s real interest rate has touched zero, it has shot back up. Japan has an aversion to negative real interest rates, it seems. And this is in stark contrast to countries like the UK and USA which have experienced much lower real interest rates since the 2008 crisis. A negative real interest rate in Japan would be a shock to the system, and a huge change for Japan’s capital-rich elderly who have happily ridden out the deflationary years in Japanese government bonds. (Of course, if reversing deflation revived real GDP growth then they would have more places to park their capital — like lending to or purchasing equity in growing business — but the question is whether or not the Japanese people at large have an appetite for such a shift).

Another challenge to growth is the existence of Japan’s zombie corporations and banks — inefficient, uncompetitive entities kept alive by government subsidies. Although some zombie banks left on life-support from the 1990s were terminated during the Koizumi years, it is fairly clear from total factor productivity figures of both Japanese manufacturing productivity and non-manufacturing productivity are still very uncompetitive. How can a burst of spending as a result of inflation turn that around? Without removing the subsidies — something that Abe, as a leader of the establishment Liberal Democratic Party, the party that has ruled Japan for the overwhelming majority of the postwar years, and is deeply interwoven with the crony industries is very unlikely to do — it may prove very difficult to return Japan to growth. And of course, these industries own the bulk of Japanese debt, so attempts to reduce the real interest rate is likely to prove deeply unpopular with them, too. (On the other hand, Japanese banks will profit from these open-market operations through flipping bonds at a profit, so the new policies may have their supporters as well as opposers among Japan’s zombie financiers).

This doesn’t necessarily mean that the Bank of Japan’s new programs are doomed to fail, or that they are likely to trigger severely adverse outcomes, but if serious attempts are not made to tackle the systemic challenges and entrenched interests, then it is hard to see how much can come out of this other than a transitory inflationary and devaluationary blip followed by a retreat to more of what Japan has become used to, and what much of Japanese society seems to like — low growth, a strong yen, and low inflation or deflation. And if Abe’s gameplan is really to grow by boosting the exports of the crony industries, then hope of desubsidisation of the crony industries seems almost entirely lost.

Certainly, more fiscal stimulus will eat up slack capital resources. And certainly, this is an interesting experiment on the fringes of Monetarism and monetary policy in general. If Japan goes through with this experiment, hits its inflation target and triggers sustained nominal GDP growth this will be a decent empirical test of whether or not such policies can lead to sustained real GDP growth. But there is no guarantee that Japan has the Rooseveltian resolve to follow through with these policies, and even if it does there is no guarantee that they will lead to a significantly higher trend in real GDP growth. The underlying system is deeply entrenched.


The Gold Standard?

Paul Krugman doesn’t believe that the gold standard was a remedy to the ills of the Great Depression:

A while back I read Lionel Robbins’s 1934 book The Great Depression; as I pointed out, it was a Very Serious Person’s book for its era. Its solution was a return to the gold standard — which would have made things worse — and free trade, which was basically irrelevant to the problem of insufficient demand.

In fact, the gold standard is almost universally shunned (with a few notable exceptions) among academic economists. In a recent survey of academic economists, 93% disagreed or strongly disagreed with this statement:

If the US replaced its discretionary monetary policy regime with a gold standard, defining a “dollar” as a specific number of ounces of gold, the price-stability and employment outcomes would be better for the average American.

When we look at the Great Depression, we need to look at things on two levels: the causes, and the symptoms. Keynesian economists — particularly Krugman, Eichengreen, etc — are focused primarily on the symptoms, particularly depressed demand, and debt-deflation. Certainly, the gold standard is not a cure for the symptoms of an economic depression.

Trying to administer austerity after a crash like 1929 or 2008 is simply a road to more pain, and a deeper depression.

The principal attraction to the gold standard is to limit credit expansion to the productive capacity of the economy. But we know very clearly that — in spite of a gold standard — there was enough credit expansion during the 1920s for a huge bubble in stocks to form.

Ultimately — even with a gold standard — if a central bank or a government, (or in the most modern case, the shadow banking system) decide that the money supply will be drastically expanded, then limits on credit creation like the gold standard (or in the modern case, reserve requirements) will be no barrier.

The amusing thing, though is that gold — perhaps because of its history as money, perhaps because of its scarcity, and almost certainty because of its lack of counter-party risk — is as strong as ever. In a global financial system where the perception of debasement of currency is widespread, gold thrives. In an era where shareholder value is thrown under the bus in the name of CEO-remuneration, where corporations are perennially mismanaged, and where profit is too-often derived from bailouts and subsidies, gold thrives. It is a popular investment both for individual investors and for non-Western central banks.

The Federal Reserve’s monetary intransigence probably did prolong the Great Depression. Certainly there were other factors — including Hoover raising taxes.  But none of that really matters now. Certainly, it is impossible that the United States — under its current monetary regime— would ever return to the gold standard. Gold’s role has changed. It is no longer state money. It is a stateless instrument thriving in a negative real-rate environment.

And unlike state monies whose values are subject to the decisions of states, gold will always be gold.

QE Infinity

A lot of hot air has shot about the internet about nominal GDP targeting, the brainchild of Scott Sumner.

Some (including the usual suspect) have said that it’s Bernanke’s next big bazooka in the (ahem) “war on economic instability“.

What the growing recognition for nominal GDP targeting reflects is a wider awakening to something I have been talking about for a long time: Irving Fisher’s theory of debt deflation. When monetary circulation drops, prices tend to drop and nominal debts tend to become much harder to repay. Therefore, the nominal value of those debts rises: workers and businesses have to produce more to pay down debts. Inevitably, this leads to more defaults. This can lead to what I (and a few others) have termed a “default cascade” — one set of large defaults leads to deflation, leading more defaults, and eventually resulting in systemic failure.

Nominal GDP targeting gives the Federal Reserve the scope to buy assets until they hit a nominal GDP target, ensuring that no such debt deflation will occur. It is — in my opinion — the most powerful monetary tool yet-imagined for reinflating burst bubbles.

As Scott Sumner puts it:

Now why is Nominal GDP so important? That’s the total dollar value of income in the economy. And if you think about it, most debts are contracted in nominal terms. So in a sense, the economy’s dollar income is a good metric for measuring people’s ability to repay these previously contracted nominal debts.

QE was — in terms of reinflating bubbles — a blunt weapon. It shot off an arbitrary amount of newly-printed/digitally-created money, with the explicit target of lowering net interest rates (and the implicit bonus of combating debt deflation). Nominal GDP targeting flips this on its head.

The problem is that this focus on monetary means will not solve the larger systemic economic problems that America and the Western world face.

As I wrote yesterday:

The problem is that most of the problems inherent in America and the West are non-monetary. For a start, America is dependent on oil, much of which is imported — oil necessary for agriculture, industry, transport, etc, and America is therefore highly vulnerable to oil shocks and oil price fluctuations. Second, America destroys huge chunks of its productive capital policing the world, and engaging in war and “liberal interventionism”. Third, America ships even more capital overseas, into the dollar hoards of Arab oil-mongers, and Chinese manufacturers who supply America with a heck of a lot. Fourth, as Krugman and DeLong would readily admit, American infrastructure, education, and basic research has been weakened by decades of under-investment (in my view, the capital lost to military adventurism, etc, has had a lot to do with this).

In light of these real world problems, at best all that monetary policy can do is kick the can, in the hope of giving society and governments more time to address the underlying challenges of the 21st Century. When a central bank pumps, metrics (e.g. GDP and unemployment) can recover, under normal circumstances that is great. But with underlying challenges like the ones we face, a transitory money-printing-driven spike is often not enough to address the structural problems, and these problems soon cause more monetary and financial woe.

What I can say about nominal GDP targeting is that it is probably the best monetary tool for buying more time. But that is completely and totally useless if America fails to address the real problems in the mean time, and assumes that the energy, military and social problems (e.g. zombification) that are the real cause of long-term economic woe will just disappear.

A larger problem is that this “solution” will probably do more (by duplicating their dollar holdings) to annoy America’s creditors, including China and Russia, who have significant scope to cause America real economic problems through a trade war.