Shinzo Abe is expected to be the next Prime Minister. He pledges to follow a familiar prescription: borrow, spend, then when you inevitably can not borrow anymore, print to pay it off with devalued currency.
Japan may avoid a hard default on public debt for a period through financial repression, such as interest rate caps and monetizing the debt, but the default will merely morph in form. Inflation is a tax and currency depreciation is a default. Of equal importance, debauching the currency is also least resistance politically. Benefits quickly become rights in the eyes of recipients. Politicians have to get reelected. One does not get reelected telling voters they overpromised.
This is compounded with delusions of grandeur; such as perhaps, ‘I can invest in alternative energy as well as Bill Gates, therefore will force people to invest in me by taxing them. I will generate a 56% return and bring unemployment down to 8% to pay for it all, even though I’m a lawyer, as is two thirds of Congress, not a scientist with a background in alternative energy. No, I couldn’t possibly have generated a negative return, and no, it doesn’t matter that investors in the private sector voluntarily take on that risk, while I force people to give to me to invest under the threat of jail (tax evasion).’
Government paper is the kerosene central bankers and their political brethren have saturated the earth with. Once ignited; it will create a forest fire. The inflation crisis will be confused with a boom, as is usually the case. Inflation can manifest in asset bubbles just as much as consumer prices.
Given the amount of Japan’s debt outstanding, it will take an unfathomable amount of inflation to generate enough asset inflation to dissolve the debt. In fact, there could be so much inflation that it ends in a currency conversion.
‘Current account reversals are usually accompanied by sudden stops, large exchange rate depreciations, and often trigger banking crises,’ show Mello, Padoan, Rousová (2011). It’s worth mentioning that thanks to government induced bubbles, China and much of Asia is also nearing a current account reversal.
Political turnover does indeed raise the odds of crises, especially of the foreign exchange and debt variety.
· “By examining political election cycles, we find that eight out of nine of the recent financial crises happened during periods of political election and transition (Mei, 1999)
· “Monthly volatilities (based on local currency returns) on average tended to be 4% higher during period of political election and transition Julio and Yook (2012).
This comes at a time when Japanese companies are losing competitiveness: Sony to Samsung, Toyota to Hyundai; Panasonic to everyone. Exports to China were already predictably weakening as one of the largest bubbles in history bursts. Rampant jingoism, long simmering since the Raping of Nanking, compounds the problem.
Tensions in the South Sea are escalating over oil resources, an ominous sign. “Historically, territory has been the most common issue over which states go to war” Taylor (2007-2008). Wars are typically the catalyst for inflation. Japan would likely lose a war with China; unless the U.S. intervenes, in which a regional dispute could escalate into world war. It is common to blame other nations in order to deflect attention from a government’s own blunders, such a move is called, “rally around the flag.” Wars and nationalism spike poll numbers higher for incumbents.
Even without conflict with it’s larger, angrier neighbor, Japan is losing the currency war to the United States and Europe. Soon, the competitive devaluation will gain new entrants as a plethora of housing bubbles in emerging markets and developed markets deflate, and fears of inflation, morph to deflation. This will inevitably push energy prices higher on a country that imports over eighty percent of its needs.
Inflation in OECD has been highly correlated over the past 45 years, with this co-movement accounting for 70% of the variability of country inflation Ciccarelli and Mojon (2005). If and when Japan’s crisis comes to the forefront, it will likely come amid a global inflation and debt crises.
Land, real estate, energy, and gold are places to hide and equities to at least hold much of their purchasing power. As for government paper, especially Yen denominated, as Voltaire said: “paper money eventually returns to its intrinsic value – zero.”
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