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:

bernanke-exhibit-20130301a1

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):

JapanRealInterestRate

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.

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Liquidation is Vital

Many Keynesians really hate the concept of liquidationism. I’m trying to grasp why.

Paul Krugman wrote:

One discouraging feature of the current economic crisis is the way many economists and economic commentators — apparently ignorant of what went on over the last 75 years or so of macroeconomic debate — have been reinventing old fallacies, imagining that they were coming up with profound insights.

The Bank for International Settlements has decided to throw everything we’ve learned from 80 years of hard thought about macroeconomics out the window, and to embrace full-frontal liquidationism. The BIS is now advocating a position indistinguishable from that of Schumpeter in the 1930s, opposing any monetary expansion because that would leave “the work of depressions undone”.

Andrew Mellon summed up liquidationism as so:

The government must keep its hands off and let the slump liquidate itself. Liquidate labor, liquidate stocks, liquidate the farmes, liquidate real estate. When the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. A panic is not altogether a bad thing. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.

In light of the zombification that now exists in Japan and also America (and coming soon to every single QE and bailout-heavy Western economy) — zombie companies, poorly managed, making all the same mistakes as before, rudderless, and yet still in business thanks to government intervention  — it is clear that the liquidationists grasped something that Keynesians are still missing. Markets are largely no longer trading fundamentals; they are just trading state intervention and money printing. Why debate earnings when instead you can debate the prospects of QE3? Why invest in profitable companies and ventures when instead you can pay yourself a fat bonus cheque out of monetary stimulus? Why exercise caution and consideration when you can just gamble and get a bailout?

Unfortunately, Mellon and his counterparts at the 30s Fed were the wrong kind of liquidationists — they could not heed their own advice and leave the market be. Ironically, the 30s Fed in raising interest rates and failing to act as lender-of-last resort drove the market into a deeper depression than was necessary (and certainly a deeper one than happened in 1907) and crushed any incipient recovery.

Liquidation is not merely some abstract policy directive, or government function. It is an organic function of the market. As the stunning bounce-back from the Panic of 1907 shows — especially when contrasted against the 1930s — a  market liquidation on the back of a panic avoids a depression. Prices fall as far as the market deems necessary, before market participants quickly come back in into the frame, setting the market on a new trail toward growth. For without a central bank, asset-holders who want to maintain a strong economy and growth (in 2008, that probably would have meant sovereigns like China and Arabia) have to come in and pick up falling masonry as lenders of last resort.

Under a central banking regime (especially a Bernankean or Krugmanite one committed to Rooseveltian Resolve) all expectations fall onto the central bank.

My own view is not just that liquidation is vital. It is that the market mechanism is vital. Without their own capital as skin in the game, central bankers are playing blind. The pace of the liquidation and the pace of the recovery should be dictated by market participants — in other words, by society at large — not by the whims of distant technocrats. Society has more skin in the game. The Great Depression was not a crisis of too little intervention — it was a crisis of too much well-intentioned intervention.

As we are learning in our own zombie depression, a central bank doing the opposite of the 1930s Fed and reinflating may solve the problem of debt-deflation, but it causes many of its own problems — zombie banks, zombie corporations, zombie markets, corporate welfarism, and the destruction of the market mechanism.

Euro Psychoanalysis

Joe Wiesenthal does some interesting analysis on Greece:

In a post last night, economist Tyler Cowen asked: “Is the goal simply to irritate the Greeks so much that they leave the Eurozone on their own?”

Here’s what might be going on.

Sometimes in life you give someone a “shot” at something that maybe they don’t deserve. You hire them, despite the fact that their qualifications were marginal. Or something like that. Bottom line is, you think you’re doing them a favor, and you’re also putting your reputation on the line a little bit. But you expect that they’ll step up and really appreciate the opportunity they have. And you expect they’ll kill it.

And when they fail — which is likely, because they might not have deserved the opportunity — you’re furious at them, because you gave them this great opportunity and they totally blew it, and they made you look like an idiot at the same time. And you just hate them for it.

And that’s what’s going on now. Europe feels like it gave Greece a “shot” with Euro membership, and multiple bailouts. And now it looks to Greece, and sees people rioting, and the reforms not happening, and they’re furious like never before. Merkel, Schaeuble, and the rest just can’t fathom that Greece was given this great shot to be a rich, wealthy European nation and it’s totally blowing it.

Well, if that’s so, Europe never really understood the creature it was creating. For all the talk of the supposed various benefits of the Euro — lower inflation, integrated markets, and so forth— its one huge dilemma — that nations were now budgeting in a currency they didn’t control, and so could not just monetise debt — was always brushed aside. Of course, policymakers were aware of some of the problems, at least in an abstract sense.

As Romano Prodi put it in 2001:

I am sure the Euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created.

I suppose what was never understood was that the problems might grow and multiply to the extent that they would pose a threat to global economic stability before such “policy instruments” were created.

I suppose the moral of the story is that it is dangerous to create systems with inherent problems, and assume that the solutions to these problems will naturally emerge later at a time of “crisis”.

And certainly, there does seem to be a sense of punishing Greece for their fiscal misdeeds (even though Germany themselves were the first nation to violate the Eurozone’s deficit rules).

From the BBC:

Some eurozone countries no longer want Greece in the bloc, Finance Minister Evangelos Venizelos has said.

He accused the states of “playing with fire”, as Greece scrambled to finalise an austerity plan demanded by the EU and IMF in return for a huge bailout.

Simply, if Europe wants to maintain the global status quo, the ECB needs to crank up the printing press, and fast, to pump huge liquidity into the system. Of course, this creates huge problems down the road, as exemplified by Japan.

If not, they had better be ready for huge changes to the global financial order. Personally, I believe that the global financial system is fundamentally broken, and that printing more money, kicking the can down the road and hoping for the best will just lead to a worse and bigger breakdown down the line. I favour liquidation. But policymakers can be very reactionary.