Japan's QE Bull Market

How QE has changed the Japanese economy in 2013, and the gloomy 2014 outlook...

 

The RISE in Japan's stock market since the introduction of aggressive QE has been impressive, writes Nathan Lewis in his detailed annual review of the Japanese economy at New World Economics.

 

But the real economy has been stagnant. Calls are going out for, yes, even more aggressive QE. And why not?

 

It seems that it has delivered nothing but advantages; perhaps more QE will deliver more advantages. Goldman Sachs suggests that a further stepup of QE could be delivered around 2Q14, perhaps in the form of the elimination of the scheduled end of the existing QE program at the end of 2014. That would simply make formal what I am expecting in any case. 

 

For both monetary and fiscal policy, the scheduled increase in consumption taxes in April 2014 is providing justification for more "stimulus". Fiscal policy follows the same endless pattern of more spending and higher taxes, that has been the case for most of the past twenty-five years. This has become so habitual that this obviously contradictory strategy can become mishmashed into a single sentence.

Unfortunately, Nikkei's English translations of the Nihon Keizai Shimbun, which I relied upon for many years for the detailed raw material I needed to find out what was really going in Japan, have been discontinued. Foreign media sources are virtually worthless.

 

Alas, my ability to read the Nikkei in Japanese has withered. But, we can get a decent idea of where things are likely to go by looking at the political platform of the major political opposition party, the Democratic Party of Japan, for 2013. 

 

The DPJ's manifesto is, as one might have guessed, rather disappointing. For the most part, it focuses on healthcare, education, public pensions, and environmental issues, typical of left-leaning parties worldwide including the US's Democratic Party.

 

Unfortunately, with a genuine need right now for major reforms of exactly these public programs, as they have become simply unaffordable in their present state, the DPJ's proposals are simply minor tweaks, mostly with the theme of giving more benefits at ultimate greater cost. But, that is simply the politics of the day; it is not yet time, politically, for major reforms here. That comes after the crisis.

 

On economic policy, the DPJ is in support of the new consumption tax rate increases. It vaguely promises a plan to produce a primary budget balance by 2020, which is total fantasy. 

 

In 2012, the DPJ was in power. The decision by the Noda administration to pass the scheduled consumption tax hike was widely blamed for the DPJ's landslide defeat in a parliamentary election in December 2012. In the dominant Lower House of Parliament, the DPJ lost 75% of its seats, falling from 230 to just 57.

 

For about the past decade or so, the DPJ has only gained popularity when it has been in opposition to a consumption tax hike, a pattern in Japanese politics going back to the 1970s.

 

In Upper House elections in July 2013, the DPJ had another huge defeat, with seats falling from 44 up for election to 17.

 

With no viable opposition, the LDP is able to do more or less what it wants to do, which is: printing money, raising taxes, and handing out money to political cronies.

 

Conclusions? Japan's tax rates are going up. Spending is going up, mostly from the endless press of social security expenditures, and no meaningful cutbacks elsewhere. In the absence of meaningful spending reforms, politicians aim to retain their political support by handing out goodies. Debts and deficits are gigantic. This leaves little but monetary policy among tools the leaders are likely to grasp for.

 

Already, the present program is seen as "not enough", leading to calls for more. Declining Yen value is the natural outcome, and indeed one unspoken purpose of this plan. This would likely be felt as an overall positive, despite negative effects such as a squeeze between higher consumer prices and stagnant incomes, until around the ¥130 per Dollar range in my estimation. Oddly, the present pace of Yen decline might put the Yen around that range by the end of 2014, just in time for the BoJ to declare its QE program a raging success. This would lead to calls for a continuation of the program, if it isn't officially prolonged sometime earlier in 2014. By that time, the Fed, ECB and BoE might also be ramping up their own monetary engines in a "race to the bottom;" thus mitigating further tendency for the Yen to fall vs. those currencies. In any case, the lower Yen value vs. other major currencies would activate the political pressure towards competitive currency depreciation in countries worldwide.

 

I don't necessarily expect JGB prices and yields to change much. Between its own bond-buying activity, and guidance of all major JGB holders including major banks and insurance companies, the level of control that has been maintained for years thus far can probably be extended. Official inflation figures can be managed such that they imply the policy outcome that is desired. Despite the supposed goal of producing a 2% or faster CPI rate, the problem with this is that it would instigate an end to the BoJ's QE program, and perhaps introduce further selling pressure on JGBs since it is a bit hard to justify a sub-1% yield with the CPI officially at 2%+.

 

In any case, official declaration that the CPI is 2% and above, while incomes are stagnant or declining, would introduce new political pressures. 

 

All in all, this is a recipe for decline and eventual disaster. The nature of the disaster is now clear. It will be via the printing press. This will eventually obliterate all existing programs and structures, because, although you can print money to infinity, the actual real economic output would decline dramatically. The result would be that there would be a much smaller pie to distribute, which thus means that all public pension, healthcare, other welfare, and other public programs would wither and essentially disintegrate. No matter what the accounting says, these programs must deliver some kind of real economic good or service, which will not be available, at least in the degree or form expected today. 

 

The society that can restructure itself without crisis is rare indeed. And long-term bull markets don't happen in the midst of long-term economic decline.

 

Read the full report on Japan at New World Economics here.