While Japan’s recent attempt to massively reflate and break out of its “liquidity trap” – an artificial construct to explain what happens when an artificial model, created by a flawed and artificial economic theory explodes in a singularity of Econ PhD idiocy leaving billions of impoverished people in its wake, is nothing new, there are those who are rather skeptical this latest attempt to achieve what Japan has not been able to do in over 30 years will work. And while one can come up with complicated, expansive, verbose theories based on Keynesian DSGE models and other such gibberish, why this time will be different for Japan, there is a very quick and simple argument why it won’t.
The simple counter-argument to this time being different is summarized in the two charts below, which show the relative asset and liability composition of the various key players in the Japanese and US market, split between the Household, Investment Trust, Pension Fund, and Insurance sectors, amounting to some $54 trillion in the US and 1.5 quadrillion yen.
The key differences are highlighted in red.
What the charts above clearly show is how vastly lower the allocation to equities is in Japan relative to the US: this means that the ‘wealth effect‘ generated in Japan as a result of the recent 20%+ surge in the Nikkei has only one fifth the impact it has had in the US. More importantly the equity asset boost resulting from perceived, if not actual, future inflation, will be woefully insufficient to offset the concurrent surge in the marginal cost of living, i.e. real inflation.
As we wrote previously, not even three full months into Abe’s latest and greatest reflation experiment the prices of gas and various other non-staple products has soared. This will only get worse as energy import costs explode in the coming weeks and months, putting the Japanese consumer – now with just one (and almost zero today) nuclear power plant and thus entirely reliant on outside sources of energy – into a spending vice, where the rise in costs far outweighs the “wealth effect” from the stock market.
The primary reason for this is that unlike the US, Japan has traditionally, culturally and historically been a nation of savers: whether this meant allocating capital into the bond market (a phenomenon which had spared the Japanese bond market from complete annihilation so far even as its debt/GDP has exploded to over 230%), or keeping it planted firmly in the bank (where it gladly collected zero percent interest).
This epic difference is best seen in the top chart, which shows that some 55.6% of all Japanese assets are in currency and deposits, compared to just 14.3% in the US.
And this is where it all begins and ends.
Prudent readers can guess where we are going from here: assuming that a few months of currency collapse manage to undo decades and generations of ingrained habits and behavioral patterns, which they most certainly can’t, assuming Abe is successful in generating his own great rotation into stocks, the question is where will the money comes from.
The answer: from the appropriate liability which matches the various “savings” tranches in the household balance sheet, namely Japanese government bonds.
That’s right: what Abe wants to do in Japan is nothing short of what Bernanke wants to do in the US – force everyone out of money markets (so far he has succeeded here – as the “great” inflow into equities, if only for the past four weeks, has not come from bonds but from money markets, which should also explain the steadfast desire of everyone from Volcker, to Geithner to the SEC to crush the $3 trillion money market industry) and out of bonds into stocks.
The problem is that in Japan a great outflow of bonds means game over. Because while in the US Bernanke just may monetize every single bond issued by the Fed without causing hyperinflation, or at least not while the shadow banking sector continues to deleverage at a pace of some $150 billion per quarter as we have shown continues to happen, Japan has no such luxury. In fact, the biggest holder by far of JGBs are various domestic pension and retirement funds, which have already indicated they may soon rotate out of bonds.
The problem is what happens once said rotation begins?
Well, the clock begins ticking. Because with a debt load of some 230% of GDP, and with debt that is 2000% of government revenue, about five times more than the second highest (Greece), a simple doubling of average interest rates means half of all government revenues goes to pay interest. Double rates again, and it’s game over for the funding side of the Japanese P&L statement, as all inbound cash will have to pay down interest, pushing Japan into the long-delayed hyperinflationary spiral.
And, by the way, none of the above is new! In fact, everything said previously has been well-known to every Japanese PM, and central banker for the past 30 years. It is also the reason why nobody has attempted the kind of ultimately suicidal move that Abe is now trying.
The good news is that it will ultimately be the bond market which puts an end to this latest bout of insanity before it is too late. Unless of course, we get bad news, which in Japan will means 2% inflation… then 12%… then 22%…. then 222% and so on.
By that point every central bank will be openly monetizing not only its own but everyone else’s debt too, as the full 1930s rerun, which most certainly included full-blown currency war just before full-blown trade war erupted, unfolds.
And as everyone knows from history, both of the above metaphoric wars in the 1930s culminated with a different war. A real one.
Source: Bank of Japan December 2012, Flow of Funds