Sunday 22 April 2018

Justin Doyle: Ireland needs to avoid Japanese- style 'recovery'

We've had five years of hell – but the Japanese have been trying to fix their economy for 22 years, writes Justin Doyle of Investec


Japan between 1984-1991 and Ireland's own boom years of 2001-2008 bear incredible similarities.

Japanese and Irish investors gorged themselves on a supply of cheap money over a similar timeframe, inflating asset prices to unsustainable levels, until... pop! Two spectacular bursts with two very similar outcomes.

Much like Ireland in 2008, Japan in the Nineties waded into years of economic malaise but just as it appeared to be waving goodbye to its Lost Decade in the 2000s, it ran into the global financial meltdown of 2007/2008.

We are fully aware how the Irish bad dream is playing out, five years after our economy imploded, but spare a thought for the Japanese as they attempt to awaken from 22 years of a nightmare.

Following nearly a generation of less than forceful monetary policy shifts, disastrous yen intervention programmes and frequent administration changes, an exhausted and disillusioned Japanese electorate voted Shinzo Abe and his LDP party back into power last December. After six years in the wilderness, Abe stormed to victory vowing to heal the Japanese economy. The symptoms include crippling long-term deflation, non-existent growth, large rolling trade deficits and an overvalued yen. How will he implement this financial panacea?

Shinzo Abe appears to have spent his six years of political exile enviously watching the US put a firm bottom on a very shaky housing/property market, turn a -4 per cent GDP rate back to a +4 per cent GDP rate, instil some semblance of confidence in the US consumer – and drag all the major US equity indices back to, and in the Dow's case, above their 2007 highs.

How did the US authorities cure such a sickly patient? The consulting surgeon, the Federal Reserve, has been drip-feeding close to zero interest rates and prescribing ongoing quantitative easing (QE). Over its various QE programmes since 2008, the Fed has expanded its balance sheet by a huge $2trn to over $3trn with the potential to add another $1trn each year this QE programme is in place.

In a similar vein to the Fed, Abe is now reshaping a more aggressive, less independent Japanese Central Bank (BoJ) as a remedy reinforced by cheap unlimited QE in an attempt to jolt the Japanese economy back to life. Can Abe's strategy of 'kitchen sinkenomics' (ie, throw everything at the problem) work?

My gut feeling is that it won't. The BoJ can throw as much quick-fix monetary stimulus as it wants at its problems but the Japanese economy cannot take off until basic structural reforms have been implemented. Deflation is the main issue in Japan – no one is spending.

How do they incentivise an ageing nation, with more than 20 per cent of its population over the age of 65, to dip into its retirement funds and start buying Sony TVs and Nissan cars? The simple answer? They won't. As a rule, 65 year olds don't tend to be the biggest spenders.

Japan has one of the worst immigration records among developed economies. Opening its doors to cheap, eager labour would stimulate employment and increase productivity. New money would boost inflation and revitalise the economy.

Like most other global central banks, the BoJ also seems hell-bent on weakening its currency to increase export competitiveness. This worked fine when Japan's nuclear power plants were firing on all cylinders. Since the Fukushima disaster two years ago and the subsequent decommissioning of most of Japan's nuclear reactors and with no natural resources to speak of, the Japanese are now reliant on imported fossil fuels.

So while a weaker yen has helped boost exports, it has had an adverse effect on the price of its largest import: fuel. This has resulted in Japan posting a record trade deficit in January. Scariest of all, however, is the lack of reference to the huge sovereign debt pile that Japan has built up over the years, which stands at a terrifying 235 per cent of its GDP.

Modelling your new monetary policy programme on a previously successful brand is easy if your economy is reasonably flexible and the work force is transient like in the US, but Japan's is not. However, the crucial question remains: Has it really been proven that the US model is a success? Surely a successful outcome can only be measured if and when the Fed decides to turn the drip-feed of eternal stimulus off. 'Normalisation' should be the ultimate judge of success.

Abe's policies reek of desperation. Some may argue he has no other choice but it is a classic case of too much, too late and in politicising the BoJ, he has eroded any credibility it may have left.

Abe has gone all-in, and unless Japan addresses its enormous debt problem and other structural/fiscal issues, investors could abruptly end their love affair with JGB's (government bonds).

I fear there could be a 'Do Not Resuscitate' order at the end of this patient's bed if that situation materialises.

Irish Independent

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