So Japan may not slide into genteel oblivion after all. To the surprise of the Japanese people, their country is smack in the middle of two riveting dramas that threaten to upturn the global strategic landscape in short order.
On the fiscal side, Mr Abe will launch combined national and local stimulus worth 20 trillion yen (£140bn) or 4.4pc of GDP. No matter that the budget deficit is already 10pc of GDP, or that total financing needs are a record 60pc of GDP this year. Photo: Bloomberg News
Newspapers may soon have to re-open their Tokyo bureaux, shut down long ago when the investment bubble burst and one Lost Decade stretched into another.
We all watch with disbelief as China and Japan rattle sabres over the Senkaku/Diaoyu islands, so like the seemingly minor events that drew Europe’s alliance systems into conflict from 1911 onwards.
Both graduated to fighter jets last week: Japan sending in F-15s; China deploying J-10s, and mobilising the East China Sea fleet for live ammo drills.
China’s purpose is clear. It is testing the US security umbrella, and Washington’s willingness to risk conflict to back Asian allies. There is a minority in Beijing who think America is a busted flush, a mistake made repeatedly by different powers over the last hundred years.
The possibility that the world’s three largest economies could come to blows — as feared by US defense secretary Leon Panetta — is a sobering thought.
Against this, Japan’s economic policy revolution seems tame. Yet forces are being unleashed that could have powerful effects through the world’s asset markets and trading system.
Premier Shinzo Abe has vowed an all-out assault on deflation, going for broke on multiple fronts with fiscal, monetary, and exchange stimulus.
This is a near copy of the remarkable experiment in the early 1930s under Korekiyo Takahasi, described by Ben Bernanke as the man who “brilliantly rescued” his country from the Great Depression.
Takahasi was the first of his era to tear up rule book completely. He took Japan off gold in December 1931. He ran “Keynesian” budget deficits deliberately, launching a New Deal blitz before Franklin Roosevelt took office.
He compelled the Bank of Japan to monetise debt until the economy was back on its feet. The bonds were later sold to banks to drain liquidity.
He devalued the yen by 60pc against the dollar, and 40pc on a trade-weighted basis. Japan’s textile, machinery, and chemical exports swept Asia, ultimately causing the British Empire and India to retaliate with Imperial Preference and all that was to follow — and there lies the rub, you might say.
Takahasi was assassinated by army officers in 1936 when he tried to tighten by cutting military costs. Policy degenerated. Japan later lurched into hyperinflation.
Few dispute that Japan escaped from slump and pioneered the world’s most successful policy mix — in strictly economic terms — from 1932 to 1936. The trick was to act with overpowering force and combine all forms of stimulus, each leavening the other.
Monetarists say Japan’s great mistake over the last 20 years has been to launch one spending spree after another without monetary backing, like sending infantry over the top deprived of artillery support. The result has been to push net public debt to 145pc of GDP this year (gross debt is 245pc) without reaching “escape velocity”.
The Bank of Japan sat of on its hands for a decade. Only later did it buy bonds, but in dribs and drabs, on short maturities, from the banking system instead of the broader public, and all in a half-hearted spirit.
Mr Abe has lost patience. This time the Bank of Japan (BoJ) will do what it is told, the first of the big central banks to be stripped of its independence, and probably not the last. As Milton Friedman said — quoting Clemenceau — “monetary policy is far too important to be left to central bankers”.
Mr Abe said the next governor to take office in April must be a soulmate “with the will and ability to pull the nation out of deflation”.
Leaks suggest that the BoJ will set an inflation target of 2pc this week, to be achieved by unlimited bond purchases.
The liquidity effects of this by the world’s top external creditor could be large enough to leak into everything from New Zealand bonds, Brazilian equities, and Chelsea property, a sort of `carry trade’ on steroids.
On the fiscal side, Mr Abe will launch combined national and local stimulus worth 20 trillion yen (£140bn) or 4.4pc of GDP. No matter that the budget deficit is already 10pc of GDP, or that total financing needs are a record 60pc of GDP this year.
The IMF advises Japan not to push its luck, warning that the country has reached the point where even a “relatively small” rise in borrowing costs could set off havoc.
“Europe’s recent experience offers a cautionary tale. Once market confidence is lost, regaining it becomes very difficult,” it said.
Mr Abe cares not a wit about such opinions, but he is taking a huge gamble. Japan is losing its safety buffers one by one. The trade surplus has evaporated, and will not recover soon after post-Fukushima closure of the nuclear industry. The savings rate has fallen to 2pc from 15pc in 1990. The work force is shrinking every year.
The state pension fund has become a net seller of government bonds as the aging effect reaches a critical point. Japan’s banks have become the buyers or last resort instead, pushing their holdings to 85pc of GDP. The result is to starve small firms of credit.
Adam Posen, a former UK rate-setter and a Japan expert, says fiscal stimulus ceased to be any help a decade ago and is now counter-productive. The risk is not that Japan’s debt trajectory will fly out of control. The damage is slow and insidious.”
When a large country with its own currency reaches its fiscal limit, growth ends not with a bang but a whimper of declining vitality,” he said. Mr Posen advises Japan to rely on monetary policy alone to right the ship.
I broadly agree, though this time the kindling wood of fiscal spending may be what is needed to ignite damp money. If Mr Abe means what he says, this is not just more of the same.
Needless to say, printing money has its perils too. The risk is that Japan could escape gentle but stable deflation — the Devil it knows — only to see a panic flight from bonds that overwhelms the Bank of Japan. As Governor Masaaki Shirakawa told the Diet through gritted teeth, “long-term yields could rise, and that would be a problem for public finances.”
Banks hold JGBs worth 900pc of their Tier 1 capital. Their portfolios would be decimated if long rates punched above 2pc. Japan might then face a banking disaster as well. These are the hard choices that Mr Abe has to make.
Nor can he continue to weaken the yen without irking Washington and jeopardising the alliance on which he depends. His rhetoric alone has already triggered a 12pc fall in the yen against the dollar, and a 20pc fall against the euro. He seems to be eyeing a dollar rate near Y100.
Mr Abe’s frustration is understandable. Japan is cursed with a safe-haven currency that strengthens in times of trouble when least wanted, the cross that creditor states must bear. Japan did uphold the G20 deal in March 2009 to refrain from “competitive devaluations”, when others did not.
But should Japan now buy foreign bonds on a mass scale to suppress the yen, there will be trouble. Tokyo will be blamed as the aggressor in the outbreak of currency wars. Others will retaliate.
Huge issues are at play here. The world’s trade system is fragile. The wasting disease behind the Long Slump is a record high savings rate of 24pc of global GDP, and too little demand to go around. Everybody wants a weaker a currency. They can’t all have it.
Japan’s great experiment cuts both ways for the rest of us: the reflation blitz helps lift the global economy out of the doldrums: but yen manipulation snatches market share, incites protectionism, and takes us into the brave new world of “actively managed exchange rates”, as Sir Mervyn King put it last month.
We will find out soon enough which is the more powerful effect.