Hyperinflation: Japan's next problem?
Jesper Koll Special to The Daily Yomiuri
Stock markets around the world are crashing and a lot of hard-earned financial wealth is being destroyed. Clearly, this is serious business that affects all of our lives. According to one survey, at the end of last year, more than two-thirds of U.S. baby-boomers still thought they could retire within the next two years due to the assumed strong performance of their financial investments. By this summer, another survey finds that more than half of the baby-boomers now expect they will have to work for at least another 10 years before they can afford retirement.
Of course, the exact degree of accuracy of these sorts of surveys can always be disputed, but the basic fact remains: The global stock market drop is destroying wealth and, if sustained, signals a coming reduction in the standard of living.
Japan has been a front-runner in the global wealth destruction game. By my back-of-the-envelope calculation, the current money amount of wealth destroyed by real estate prices falling back to 1982 levels and the stock market plunging to 20-year lows is more than the total wealth destroyed by the Great Kanto Earthquake of 1923 and the Pacific War combined.
Yet despite this, the country appears to be doing fine. Nowhere is there any meaningful sense of crisis. Yes, unemployment is rising and bankruptcies are creeping higher, but at the same time luxury sales continue to rise, a record number of new condominiums and office buildings are being built and Japan remains unchallenged as the world's largest creditor nation. Wealth destruction--yes. Economic stagnation--yes. Crisis--no!
For an economist there is a very straightforward explanation for this apparent mismatch. Again and again, Japan has borrowed from the future to postpone the inevitable decline in living standards that is forced by the collapse of yen-based asset markets. From my perspective, the worry from this point on is not that some one-off trigger event will spark a real crisis. The worry is that the inevitable paying back of all the money borrowed will increase the drag on growth. After all, rising debt repayments will reduce the economy's ability to invest in the future. Japan's future outlook is clouded by a high probability of stagnation and "muddle through." If the past 10 years are any guide for the future, no one should ever underestimate the capacity of the Japanese people to tolerate and endure stagnation.
What could spark a real crisis in Japan? I think there are three main risk scenarios: capital flight, a current account deficit, and hyperinflation.
Capital flight is the most serious of all the risk scenarios. Japan has a massive savings surplus and, at the same time, has no non-yen currency liabilities. Japan owes nothing to the world and, de facto, all its debt is funded by its own savers. This works fine as long as Japanese savers have full trust in their currency and the institutions that intermediate the flow of savings into investments.
If this trust breaks, savers would rush to convert out of yen-savings instruments and into dollar or euro assets. It would be like pulling out the carpet from underneath the financial system, similar to what happened in Argentina recently or Indonesia a couple of years ago.
To be sure, the probability of accelerated capital flight is extremely low. For example, even with 10 years of a banking crisis in place, private bank deposits are still growing at a steady 2 percent to 3 percent pace. While there is some concern over smaller regional banks, the overall banking system is flush with liquidity and sees steady increases in deposit funding.
As long as this persists, the banks will use these funds to buy government bonds, with the increased powers of regulatory authorities openly encouraging stepped-up purchases of Japanese government bonds (JGBs) and other yen assets. A domestic "buyers strike" for JGBs is thus kept in check. More importantly, Japanese savers have a very high home currency preference. They live their lives here, have yen mortgages to pay back and have absolutely overwhelming desire to retire here in Japan.
The second risk scenario is Japan loosing its status as a creditor nation. If Japan started running a current account deficit, then foreigners would become the marginal buyer of yen assets in general, yen government debt in particular. Foreigners buy yen assets against non-yen liabilities. So they will inevitably demand a currency risk premium before buying more JGBs. In addition, foreign investors will demand a credit risk premium because for them the credit rating by the global rating agencies actually matters.
So a current account deficit would result in a temporary "buyers strike," pushing up bond yields. Domestic portfolios would suffer capital loss and, more importantly, Japanese corporations would see an increase in their own cost of debt, which would inevitably push many of them into bankruptcy.
Hyperinflation seems like the most far-fetched of all the risks. After all, deflation has been with Japan for almost three years and is still accelerating. However, from a medium- to long-term perspective, hyperinflation risks are actually rising in Japan. The reason is the more and more aggressive monetization of public debt by the Bank of Japan. This year, about 40 percent of the government's new borrowing will be purchased by the central bank--up from barely 15 percent last year.
Why does this raise inflation risks? For an economist, inflation stems from too much money chasing too few goods. With the Bank of Japan raising aggressively the amount of money in circulation--they buy the JGBs with money printed--sooner or later there will be more money chasing too few goods.
Right now, the combination of massive excess capacity and idle showrooms, together with consumers' reluctance to spend, makes it seem far-fetched to talk about too much money chasing too few goods. Indeed, the only exceptions where this is true seems to be maybe too much money chasing too few safety deposit boxes and futons. However, this can change very fast and very unpredictably.
Of course, there are other country risk scenarios that one could consider, like a trade war with Asia, oil prices at 60 dollars per barrel, or a terrorist attack on Japan.
But from an economist's perspective, these three are the main ones. Indeed, the most likely one may very well be hyperinflation, at least according to economic textbook. The usual problem is, unfortunately, that economists can tell you how it will happen, but not when. But one thing is for sure--Japan's standard of living has a high probability of declining. Hyperinflation would just be the most extreme form of this as it cuts the purchasing power of the peoples wealth very sharply, very quickly.
Hyperinflation: Japan's next problem?
Jesper Koll Special to The Daily Yomiuri
Stock markets around the world are crashing and a lot of hard-earned financial wealth is being destroyed. Clearly, this is serious business that affects all of our lives. According to one survey, at the end of last year, more than two-thirds of U.S. baby-boomers still thought they could retire within the next two years due to the assumed strong performance of their financial investments. By this summer, another survey finds that more than half of the baby-boomers now expect they will have to work for at least another 10 years before they can afford retirement.
Of course, the exact degree of accuracy of these sorts of surveys can always be disputed, but the basic fact remains: The global stock market drop is destroying wealth and, if sustained, signals a coming reduction in the standard of living.
Japan has been a front-runner in the global wealth destruction game. By my back-of-the-envelope calculation, the current money amount of wealth destroyed by real estate prices falling back to 1982 levels and the stock market plunging to 20-year lows is more than the total wealth destroyed by the Great Kanto Earthquake of 1923 and the Pacific War combined.
Yet despite this, the country appears to be doing fine. Nowhere is there any meaningful sense of crisis. Yes, unemployment is rising and bankruptcies are creeping higher, but at the same time luxury sales continue to rise, a record number of new condominiums and office buildings are being built and Japan remains unchallenged as the world's largest creditor nation. Wealth destruction--yes. Economic stagnation--yes. Crisis--no!
For an economist there is a very straightforward explanation for this apparent mismatch. Again and again, Japan has borrowed from the future to postpone the inevitable decline in living standards that is forced by the collapse of yen-based asset markets. From my perspective, the worry from this point on is not that some one-off trigger event will spark a real crisis. The worry is that the inevitable paying back of all the money borrowed will increase the drag on growth. After all, rising debt repayments will reduce the economy's ability to invest in the future. Japan's future outlook is clouded by a high probability of stagnation and "muddle through." If the past 10 years are any guide for the future, no one should ever underestimate the capacity of the Japanese people to tolerate and endure stagnation.
What could spark a real crisis in Japan? I think there are three main risk scenarios: capital flight, a current account deficit, and hyperinflation.
Capital flight is the most serious of all the risk scenarios. Japan has a massive savings surplus and, at the same time, has no non-yen currency liabilities. Japan owes nothing to the world and, de facto, all its debt is funded by its own savers. This works fine as long as Japanese savers have full trust in their currency and the institutions that intermediate the flow of savings into investments.
If this trust breaks, savers would rush to convert out of yen-savings instruments and into dollar or euro assets. It would be like pulling out the carpet from underneath the financial system, similar to what happened in Argentina recently or Indonesia a couple of years ago.
To be sure, the probability of accelerated capital flight is extremely low. For example, even with 10 years of a banking crisis in place, private bank deposits are still growing at a steady 2 percent to 3 percent pace. While there is some concern over smaller regional banks, the overall banking system is flush with liquidity and sees steady increases in deposit funding.
As long as this persists, the banks will use these funds to buy government bonds, with the increased powers of regulatory authorities openly encouraging stepped-up purchases of Japanese government bonds (JGBs) and other yen assets. A domestic "buyers strike" for JGBs is thus kept in check. More importantly, Japanese savers have a very high home currency preference. They live their lives here, have yen mortgages to pay back and have absolutely overwhelming desire to retire here in Japan.
The second risk scenario is Japan loosing its status as a creditor nation. If Japan started running a current account deficit, then foreigners would become the marginal buyer of yen assets in general, yen government debt in particular. Foreigners buy yen assets against non-yen liabilities. So they will inevitably demand a currency risk premium before buying more JGBs. In addition, foreign investors will demand a credit risk premium because for them the credit rating by the global rating agencies actually matters.
So a current account deficit would result in a temporary "buyers strike," pushing up bond yields. Domestic portfolios would suffer capital loss and, more importantly, Japanese corporations would see an increase in their own cost of debt, which would inevitably push many of them into bankruptcy.
Hyperinflation seems like the most far-fetched of all the risks. After all, deflation has been with Japan for almost three years and is still accelerating. However, from a medium- to long-term perspective, hyperinflation risks are actually rising in Japan. The reason is the more and more aggressive monetization of public debt by the Bank of Japan. This year, about 40 percent of the government's new borrowing will be purchased by the central bank--up from barely 15 percent last year.
Why does this raise inflation risks? For an economist, inflation stems from too much money chasing too few goods. With the Bank of Japan raising aggressively the amount of money in circulation--they buy the JGBs with money printed--sooner or later there will be more money chasing too few goods.
Right now, the combination of massive excess capacity and idle showrooms, together with consumers' reluctance to spend, makes it seem far-fetched to talk about too much money chasing too few goods. Indeed, the only exceptions where this is true seems to be maybe too much money chasing too few safety deposit boxes and futons. However, this can change very fast and very unpredictably.
Of course, there are other country risk scenarios that one could consider, like a trade war with Asia, oil prices at 60 dollars per barrel, or a terrorist attack on Japan.
But from an economist's perspective, these three are the main ones. Indeed, the most likely one may very well be hyperinflation, at least according to economic textbook. The usual problem is, unfortunately, that economists can tell you how it will happen, but not when. But one thing is for sure--Japan's standard of living has a high probability of declining. Hyperinflation would just be the most extreme form of this as it cuts the purchasing power of the peoples wealth very sharply, very quickly. |
