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Myth of Japan's Failure


bmichaud
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One point he leaves out is the debt isssue which could destroy the economy pretty quickly.  A good portion of the growth was created via debt (similar to the US/Europe) so the debtholders (primarily citiznes) will be the ones hurt once the debt burden blows up.  The failure has been deferred via borrowing but not eliminated. 

 

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There won't be a crisis as long as Japan is a monopoly supplier of its own currency. The US, UK and Japanese governments spend first, tax second, and issue bonds third - they are in complete control of their currency as long as their economy remains productive. In the event the economy collapses, then the currency would be rejected and hyperinflation would result. Europe is effectively on the gold standard because it must first issue bonds to the market or tax its citizens PRIOR to spending - thus Europe is a ward of the markets, as evidenced by the current crisis and spiraling interest rates.

 

Super important distinction - currency ISSUERS spend first, tax and issue bonds second, while currency USERS must tax and issue first prior to spending. Thus bonds of currency ISSUERS are 100% free of capital return risk, whereas the bonds of currency users are not. As households, we are like Europe - we can't pay our credit card without dollars in hand. If we could create dollars, then we could always pay our credit card.

 

The primary responsibility of a currency issuer is to not induce hyperinflation via persistent, unproductive spending. We shall see how long it will take for US, UK and Japanese citizens to reject their respective currencies. My bet is those currencies won't be rejected any time soon if ever. I'll take the other side of a bet against a currency issuer any day of the week.

 

How does this viewpoint help us as investors? It keeps us out of unproductive, unprofitable hedges against US hyperinflation, or bets against currency issuers; it keeps us from rooting against the current deficit spending that is just barely keeping the US private sector afloat and able to spend money on the products our companies produce that in turn provide a return our investment; and it makes us aware of the truly hideous combination of a debt spiral and forced austerity measures being implemented over in Europe and the impact that will have on the global economy and financial system.

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I think Japan will run into a problem when it has to issue large amounts of yen bonds to foreigners (which it hasn't had to due to high savings rate amongst the working population).  At that point they are at the mercy of the markets.  That is the situation in Europe, they have to issue bonds to foreigners to provide for spending.  The US is somewhere between Europe and Japan.  What may hit Japan is demographic but it may be blunted if they can invest thier capital wisely to offset the decline in population.  If older folks can stay productive and continue to save and pay into the system they are fine.  If they want to collect and live on the golf course then they will have a problem. 

 

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Who buys the bonds is irrelevant for a monopoly currency supplier - bond issuance is simply a tool to soak up reserves in the banking system. So the Japanese central bank/central government swaps Yen bonds for Yen currency within the banking system. But again, bond issuance is irrelevant for spending - the Japanese government spends first, injecting Yen into the private sector, then it issues bonds, swapping them for the newly created reserves created via spending. So the Japanese citizens wouldn't have to buy a single bond from hereon out and the government would be fine.

 

Just look at what happened when the Fed stopped QE2 - the Fed stopped "funding" government bond issuance, and the Treasury market never skipped a beat. China could discontinue purchasing USTs for the rest of time and nothing would happen - they can choose to hold the USD they accumulate from running a current account surplus in a bank account yielding nothing, or they can invest their USD in Treasury bonds.

 

European governments are at the mercy of the market because they gave up their right to print money, as Buffett likes to say. The European countries are like the US states over here - they cannot print money, thus they must first tax or issue debt before spending. Europe is missing a central treasury that would work in tandem with the ECB, spending/printing newly created Euros, and issuing Euro treasury bonds to soak up the reserves. A centralized treasury/central bank would be able to balance out the trade imbalances within the Eurozone as well as run deficits in order to offset the austerity measures being implemented across the Euro "states".

 

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Isn't the ability to have no effect a function of having a trade/capital surplus?  Once this reverses as the countries age, they will have to get funds from abroad to provide funds for the promised benefits.  The US is able to do it with a deficit because it is a reserve currnecy and more trusted than the alternatives.  There must be a limitation on the system you have described or it would be a perpetual money machine and the Europeans would have done this also.

 

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It is a perpetual money machine. The US/UK/Japan have an enormous responsibility to not abuse their respective positions as monopoly currency suppliers and flood the world with their currencies (currencies meaning actual hard currency as well as treasury bonds - both are in effect the same thing in this system). The limitation is inflation, and this is regulated by taxation, since taxation is the only means for removing currency from the system.

 

they will have to get funds from abroad to provide funds for the promised benefits.

 

Unless the US/UK/Japan borrow in a foreign currency, then there is no such thing as "getting funds from abroad". Think about it - when Chinese companies sell US consumers their goods, we pay them in USD. The Chinese companies convert those USD into Yuan, which inherently drives up demand for Yuan and strengthens the currency. In order to offset this demand, the Chinese government prints Yuan in order to buy the USD from Chinese companies - this weakens the Yuan while simultaneously creating demand for USD as the Chinese government buys USD. So at the end of this cycle, the Chinese government is sitting on a huge pile of USD - they can either hold the USD in a bank account earning 0%, or they can buy Treasury bonds yielding .25% to 3% depending on the maturity. China must FIRST obtain USD before investing in US Treasury bonds. It only makes sense - they can't purchase US denominated assets, including US Treasury bonds, before FIRST obtaining USD. The process is the same for Japan and the UK - Yen and Pounds are first spent into existence, then Yen bonds and Pound bonds are issued. So once the currency is in the banking system, the central bank/central treasury can simply swap bonds for currency via the central banking system. Who purchases the bonds is irrelevant as demonstrated by the US Treasury market not skipping a beat when the Fed left the market.

 

It's the complete opposite for Germany/France/Italy - if those countries have zero Euros in their coffers, then they must first tax their citizens or issue Euro bonds to Euro currency holders seeking an interest-bearing asset in order to spend. They cannot spend first because they cannot print Euros - only the ECB can print. The ECB could initiate a massive EUR1 trillion infrastructure project if they so desired, and simply pay all the contractors and private sector construction workers by crediting their bank account with the one-trillion Euros. The EUR1 trillion would be spent/printed into existence. This hypothetical infrastructure project would be inflationary in a normal environment if the ECB did not simultaneously tax perhaps EUR750 billion out of the system, in effect, running a EUR250 billion deficit. This example is the precise mechanical outline of a monetary system operated by a monopoly currency supplier such as the US/UK/Japan. We can only hope Europe will adopt this system, and finally put the finishing touches on what is inevitably a United States of Europe. If they don't, they risk a break-up and....

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  • 1 month later...

bmichaud, I don't understand your argument fully (more a comment on my capacity for macroeconomics than your explanation!) but I cannot see how the Japanese situation can be susrtainable in the long term.  IIRC, Japan's working-age population is falling at 0.6% a year this decade and accelerating to double that in the 2030s.  This will make it very hard to grow GDP at a rapid rate.  Yet its government debt:GDP is 100% and rising at 10% a year.  Surely this has to end either with big tax rises/cuts in government spending, or rapid inflation? 

 

Put another way, you're right that governments with control over their currency can "spend-then-print" so long as they control inflation - but that is a key caveat and it is not compatible with building debt for ever.

 

The only bright spot I can see is that total debt (govt+corp+private) has been falling slowly.  So perhaps there will come a point where corp/private releveraging can allow the government to delever without sucking money out of the economy.  But I don't see it, not when government spending is driven by entitlements (get worse with aging) and interest (which are 25% of tax intake even when rates are 1%). 

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