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Friday, November 23, 2012

Is Japan really on the brink of a sudden downward spiral?

Japanese banks are by some measures in better shape than their UK counterparts, but the rest of the economy is looking decidedly shaky

First Britain was compared to Greece – sunk by debt. Then when the worst of the financial crisis passed and a battered exchequer was still solvent, Britain was likened to another capitalist basket case - Japan.

With two lost decades under its belt, Tokyo is considered the capital of stasis, a place where nothing grows.

Hardly a week goes by without someone arguing that Japan's lack of growth, its ageing population, massive debts or its strong currency spell the end of a renaissance that propelled the country into the first rank during the 1970s.

To many people the situation remains benign. If you are happy with your domestic situation, job and income, an economy that is going nowhere does little to provoke the forces of change. So far outside investors have adopted a similar view.

However, not everyone is content.

The traditional prop for a government that repeatedly spends more than it generates in taxes, is the Japanese saver. They put their money aside to lend to their own government. Japanese government bonds (JGBs) are famously 95% owned by Japanese investors (who believe misguidedly that it is better to get a return on loans to the government than pay tax, which has no return).

Japan's savers have been ageing for some time. Every year there are fewer people putting money aside. In recent times the banks have made up the difference, but this has only made the situation worse as they tie themselves to the fortunes of the government in an ever-closer union.

Polls this week showed the refusal to pay enough tax persists and voters are turning to opposition leader Shinzo Abe's plans to unleash unlimited amounts of free cash to push inflation up to 3% and interest rates below 0%.

This free cash is printed by the central bank and will flood the Japanese financial markets in the hope that some people will spend it. It is a scheme that has worked in the US, but in Japan is more likely to mimic the Bank of England's quantitative easing programme, which has flopped as a spur to growth. In the UK, the people who benefit - those who discover their debt payments are cheaper - tend to hoard the savings while those without debts find their income cut as savings interest declines. All the new money gets swallowed by the banks, which are grateful because they are also suffering terribly, and recycled back to the government.

Japanese banks are by some measures in better shape than their UK counterparts, but the rest of the economy is looking decidedly shaky.

Exports fell in October by 6.5% on the previous year (imports dropped by 1.6%). Exports to the EU are down 20%, while exports to China have slumped by 11.6%, in part due to tensions over disputed islands in the East China Sea. Sony, Panasonic, Sharp are on the slide along with much of the tech sector.

Worse, domestic consumption dropped 0.5% and capital expenditure fell 3.2%, both registering the second-largest falls since the height of the 2008-09 recession.

Graham Turner at GFC Economics says Japan stands on the brink of an almost complete reversal in fortunes. After years of rising spending and debt, supported by domestic and foreign lenders, the government could find itself spiralling downwards.

He says: "The determination of the government to beat deflation via a loose fiscal policy could be the tipping factor, which drives the current account deeper into deficit. In this respect, Japan may begin to mirror the peripherals of the eurozone, prior to the euro crisis, where a loose fiscal policy goes hand in hand with poor external fundamentals."

The poor external fundamentals he refers to are the lack of demand for Japanese goods and the increasing unease of foreign lenders at Japan's plight. Already the interest rate the government pays on its debt has risen. It doesn't need to go up by much to add billions of pounds to the bill.

George Osborne is also looking at rising debts and zero growth. He is relying on the Bank of England to create growth with money created in the bowels of Threadneedle Street. We didn't want to follow Greece, and we don't want to be the next Japan. If we continue on the same path we will undoubtedly have the same outcome.


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