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Japan taking big gamble with QE program

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Saturday, June 8, 2013, 9:00 p.m.
 

Responding to a decade of depressed consumer demand, Haruhiko Kuroda, governor of the Bank of Japan, announced this spring a program of quantitative easing of about $1.4 trillion by 2014 to boost the island nation's economy.

The amount followed — and even exceeded — the relative size of Ben Bernanke's prior QE for the U.S. economy.

The Japanese Yen, along with the euro, is a secondary international reserve currency held by major investors — including central banks — as a form of risk diversification away from dollars. There is little doubt that if Kuroda's gamble fails, it will have major international repercussions, possibly heralding a global currency crisis.

Recent volatility in Japanese financial markets indicates growing concern.

Japan emerged from Word War II economically broken. Like Germany, Japan received reconstruction aid from the Allied powers. Armed with a high, Germanic work ethic and preparedness to embrace modern technology, Japan's economy became second only to that of the United States.

Unlike Germany, however, Japan's politicians shared with the Allied powers a Keynesian belief in public debt. As a result, Japan enjoyed phenomenal economic success in the 1960s and early 1970s. That burst in the early 1990s, leading to a decade of economic stagnation, strangely similar to that which infected the United States and European economies about a decade later.

Japan used QE programs, taking its debt-to-gross domestic product ratio to a staggering 214 percent, far higher than any other developed nation. Because Japan generated continuous trade surpluses, no one complained. However, trade deficits forecast for this year have led to calls for dramatic action.

In 2010, China pushed Japan's $5.5 trillion economy into third place. Excluding the European Union as a single economy, Japan's shrunken economy at $5.1 trillion is still the world's third largest, but only about a third of the $16.2 trillion U.S. economy.

Kuroda's open-ended $1.4 trillion cash infusion was equivalent to a U.S. Federal Reserve QE of about $4.5 trillion. In other words, it was huge. Meanwhile, the yen has continued its steady, 30-percent fall since September, leading to hopes of increased exports. Japan's Nikkei 225 Index broke even at a five-year high of 13,000 on April 5th.

Since no QE has succeeded in recent years, the ramifications of a failure will be far-reaching for the credibility of international fiat currency. Kuroda's stated aim is to generate 2 percent inflation. With that outlook, combined with current yields of less than one percent and forecast deficits, many traditional domestic buyers of Japanese government debt have diversified into foreign bonds. This has driven the yen down further and the Japanese 10-year bond yield upwards three fold to 1.0 percent.

Kuroda's QE now is generating concern within Japan. Hopefully, such fear will not spread to the QE programs of the U.S. or EU.

Regardless, investors should keep their eyes on the progress of Japan's great gamble.

John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Email him at johnbrowne70@yahoo.com.

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