By David Stockman, Budget Director under President Reagan and author of the bestseller, The Great Deformation: The Corruption of Capitalism in America. This article originally appeared on David Stockman’s Contra Corner.
You would think that Japan would be a blinding object lesson in the folly of Keynesian economics. After all, Japan has gone all-out on both fiscal stimulus and massive central bank balance sheet expansion and interest rate repression. Indeed, the US incursions into that fantasy world are somewhat modest by comparison: Japan’s gross public debt is 240% of GDP compared to 100% in the US; and its central bank balance sheet of nearly $3 trillion amounts to more than 40% of GDP. That vastly exceeds the 25% of GDP balance sheet generated by the mad money printers in the Eccles Building to date.
But the lessons go far beyond balance sheet ratios. Japan’s rapidly aging demographic profile—its population is now actually declining— is only an advanced case of the US path over the next several decades. Likewise, its inability to close its yawning fiscal gap—last year it borrowed nearly 50 cents on every dollar of government spending—is a function of the same malady of governance that afflicts the Washington beltway. Namely, the domination of a nominal democratic process by crony capitalist gangs which resist all efforts to curtail privileges, subsidies, and entitlements.
Japan is rapidly become a vast old age home buckling under the weight of a monumental accumulation of public, household, business and financial debt. Current estimates for total debt outstanding amount to nearly 500% of GDP—a figure which would be equivalent of $85 trillion on a US economic scale.
These staggering debt burdens have prevented Japan from returning to normal economic growth—ever since its giant financial bubble collapsed 25 years ago after the Nikkei average had nearly hit 40,000 (vs. 14,000 today). The aftermath has been described as chronic “deflation”, but the true meaning of that term has been badly twisted and distorted.
What actually happened during the final stages of Japan’s 1980s bubble is that ultra-cheap interest rates caused financial and real estate values to become drastically inflated. Similarly, cheap capital resulted in massive over-investments in long-lived industrial assets like auto plants, steel mills and electronics plants.
So the deflationary aftermath of its bubble was an unavoidable and inexorable economic process. That is, real estate got marked down by upwards of 80%; stocks fell by even more; excess industrial capacity was steadily eliminated; and massive bad debts have been liquidated by Japan’s unique slow-motion process.
In short, Japan’s actual “deflation” has been overwhelmingly a balance sheet contraction—the inverse of the great asset and debt inflation which preceded it. By contrast, household incomes have only eroded slightly and goods and services prices have fluctuated along the flat-line for more than 20 years. As shown below, the ailments of the Japanese economies were sown in the false boom before 1990, not in plunging consumer prices since then.
Indeed, Japan’s CPI index today—after 17 months of strenuous, but wrong-headed efforts by the Abe government to rekindle inflation—stands virtually at the exact spot where it stood in early 1993. Moreover, the narrow band of fluctuation in the interim amounts to only a few percentage points around the index base of 100. Ironically, economists a few decades ago would have uniformly praised the price stability path shown below—not identified it as the root cause of economic evil as have today’s clueless Keynesians.
The false Keynesian “deflation” canard has led to the catastrophe known as Abenomics. In a decade or two, nearly 40% of the Japanese population will be retired. The last thing it needs is zero interest rates owing to the massive monetization of debt by its central bank. And the single-risk it should never take is to induce a collapse of its currency, and the resulting sharp inflation of its import bill for virtually all the energy and industrial materials that the island consumes.
That would eventually result in an actual sharp decline in real household incomes compared to the post-1990 stability; and an outbreak of end-of-the-world disorder in its debt and financial securities markets were CPI inflation ever actually let loose.
Unfortunately, Japan is headed in exactly that direction. As reports on its collapsing balance of payments for the fiscal year just ended make clear, Abenomics has caused imports to soar, corporate Japan to off-shore more production, and export prices to rise only slightly without any gains in real volumes.
In short, Japan’s live-fire test of Keynesian central banking against the mirage of deflation has already proceeded far enough to know the answer: It is a world class disaster, yet one that Janet Yellen and here merry money printers seem determined to replicate. By David Stockman. Check out his bestseller, The Great Deformation: The Corruption of Capitalism in America, and while at it, check out my 5-star review (in 2nd place). This article originally appeared on David Stockman’s Contra Corner.