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Bad Medicine: Quantitative Easing In Japan

After over a decade of rising deflation that has in many ways crippled the Japanese banking industry and stifled economic growth, Japan’s newest prime minister, Shinzo Abe, has introduced a comprehensive plan to undo years of fiscal decline and insolvency. Dubbed by economists “Abenomics”, Abe’s economic plan consists of drastically overhauling Japan’s labor market, lowering interest rates to unprecedented levels, and reforming trade practices in order to set into motion a solid trend of growth. However, one of the most controversial components of Abe’s plan risks to completely doom Japan’s already stalled economy. Known in the financial lexicon as “quantitative easing” (QE)—the deliberate creation of capital and buybacks of government bonds—, the unorthodox financial practice aimed to raise inflation rates to a reasonable threshold could potentially spiral out of control, while diminishing demand for Japanese currency, depressing wages, and risking further insolvency for banks across the archipelago.

The advent of quantitative easing dates back to early 2001, during which period Japan suffered the persistent blights of crippling deflation. The logic behind QE stipulates that by injecting mass amounts of new capital into the economy and by buying up government bonds, inflation rates would gradually rise to favorable levels. In essence, to simplify, the more currency circulating in an economy theoretically translates into lower currency value, naturally leading to increases in price. After nearly a decade of stagnant prices and continual devaluation of Japanese goods and services, newly elected Prime Minister Shinzo Abe (LDP)[1] announced a series of comprehensive bouts of easing aimed to curtail the effects of deflation. Working closely with central bank governor Haruhiko Kuroda—the rough equivalent of the U.S. Federal Reserve Chairman—Abe unleashed a massive quantitative easing policy (QEP) worth over $1.4 trillion. The plan stipulates that the Bank of Japan would purchase over ¥7 trillion[2] worth of Japanese government bonds on a monthly basis using electronically created money.[3] Despite extensive effort, Abe’s QEP proved ultimately to be a failure in addressing the underlying issues as inflation remained undesirably low and consumer spending continued to stagnate. In a desperate pitch, Kuroda announced additional hikes in easing, raising the amount of bonds the Bank of Japan would purchase to nearly ¥80 trillion per year. Despite marginal boosts in economic activity—particularly in regard to increased investment in Japanese securities—the higher inflation rates anticipated have done little to spur credit demand as “continued aversion to debt among firms and households may be blunting the effectiveness of this channel”, according to Adam Slater, senior economist at Oxford Economics.

In effect, the long term implications of continual QE are manifold. Firstly, Japanese wages have suffered gradual depreciation despite projections by policymakers that a weaker yen would carry over to higher profits for exporters, “triggering stronger business investment and trickle down to higher wagers, which will lead to more domestic consumption and growth.”[4] Yet economic trends in Japan tell a different tale. In essence, exporters have largely ignored yen depreciation by not slashing prices overseas to up global market shares. Rather, firms “have kept overseas prices roughly the same and exploited the weaker yen to book higher […] earnings”, according to the Wall Street Journal.[5] According to recent records, exports have flat-lined and remain at approximately 25% less than pre-2008 levels. Less investment, likewise, undermines worker productivity that has drastic implications for long term economic growth. Further, the weaker yen effectively raises the cost of imports for Japanese working families, making any alleged increase in wages negligible due to the consequent costs. Secondly, the high frequency bond buybacks by the Bank of Japan sets an unhealthy precedent that feigns a solution to economic stagnation in place of substantive bureaucratic reform. According to the Japan Times, Japan’s massive buybacks could in fact force the government to “keep issuing even more bonds to finance itself despite its snowballing debt.”[6] At the present time, Japan holds a public debt worth more than 230% the value of its GDP.[7] Essentially, Abe’s QE is not working and has only fueled market speculation by gradually depreciating the value of the yen.[8]

Amid other concerns, one of the central risks posed by extensive QE measures involves the long term risk of igniting a full-fledged hyperinflation crisis—effectively setting the Japanese economy on the express track to complete and utter ruin. According to Bloomberg Business, “inflation risk, on the other hand—not knowing what it will be in the future or a lack of confidence in your prediction—can be destructive. It makes it harder to set wage contracts, decide how much to spend, how much to produce, and what to charge.”[9] In other words, the long term implications stipulate that the mass printing of currency and bond buybacks risk undermining investor confidence in currency value, which historically leads to increased savings as opposed to outright spending—a trend feared by economists and politicians alike, as the financial health of a country is contingent upon the free flow of capital in an economy. Further, even if QE does not initially result in high inflation, the Bank of Japan (or any central banking institution for that matter) runs the potential cost of losing its credibility, making the real risk of inflation all the more real.[10] This notion again is predicated on a lack of investor confidence due to increased speculation and volatility in regard to currency value. The potential impacts, should inflation run out of control, risk floundering an already trembling Japanese bond market, discouraging spending and investment by forcing up interest rates, and impeding trade as a result of currency devaluation. Effectively, while QE may result in some short growth, the long term risks make it a politically unfeasible solution. Indeed, extensive easing has proven largely ineffective in addressing the root issues at hand and has jeopardized economic stability in Japan.

Looking forward, Japanese leaders must consider serious questions in the next fiscal quarter. At a critical time, with a recovering Wall Street in America, a shaky bond market and low productivity output in Beijing, Shinzo Abe must weigh all potential solutions in order to assuage his nation’s economic stagnation. Quantitative easing proves an unnecessary risk with minimal long term returns. The solution to economic issues—avoiding deflation being at the forefront—must involve a more comprehensive focus on bureaucratic reform in labor markets, reducing the unpopular consumption tax, and streamlining exports as opposed to a risky and unorthodox monetary policy whose merits bear little credence and in fact risk further harms down the line.

Sources:

[1] Liberal Democratic Party of Japan

[2] Japanese yen: Exchange rate as of Nov. 2015 stands at roughly ¥1 to $0.01

[3] Katie Allen, “Quantitative easing around the world: lessons from Japan, UK, and US”, The Guardian, January 22, 2015

[4] Kevin Lundberg, “Japanese Devaluation Warning for Europe”, The Wall Street Journal, March 16, 2015

[5] Ibid

[6] Reigi Yoshia, “BoJ’s easing said unsustainable”, Japan Times, April 6, 2015

[7] Ibid

[8] Floyd Norris, “Inflation? Deflation is New Risk”, New York Times, October 30th, 2015

[9] Allison Schrager, “The Hidden Inflation Risk in Ending the Fed’s Bond-Buying Program”, Bloomberg Business, July 15, 2015

[10] “The Bank of Japan keeps printing money at speed”, The Economist, October 30th, 2015

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