As many of you know, my lifetime career has been that of international fixed-income cash and futures trader. I have also traded commodities, equity indices, and foreign currencies.
In contrast, during the past 40 years I have enjoyed an active sideline of teaching.
My subjects of specialization have included the teaching of Finnish, economics, religion, band, and jazz orchestra. As an avocational instructor, I was once taught a simple model for learning which has remained with me for four decades.
According to the model, learning requires five steps, whose titles are somewhat self-explanatory. They include, first, initial exposure; second, repetition; third, understanding; fourth, acceptance; and fifth, application. We come to understand a principle after multiple exposures. Learning is completed when the principle is not only accepted, but also implemented.
This week’s column might fall into the category of repetition, since we have discussed today’s topic in past columns several times in several ways. The subject du jour has sprouted from our seedling last week regarding recent Japanese economic experiences.
First we examine a bit of history. April of 1989 was a memorable month in my life as a trader. The Nikkei Dow equity index (similar to our S&P index) had rallied to a shade shy of 40,000 points, and then commenced the collapse. Eventually, the tumultuous tumble took the Japanese stock market down below 7,000: a fall of more than 80 percent!
During the 25 years since the outset of the onslaught, Japan has had to cope with a near constant shortfall in aggregate demand. In other words, a lack of spending on the part of households and businesses has been the new normal in Japan for just over a quarter of a century. Recall that a lack of spending produces unemployment.
Why have the Japanese been spending too little (or saving too much)? Part of this is cultural. Japan has traditionally been a nation of savers. A second factor is the dwindling population augmented by an aging citizenry, but an all important contributor has been the low stock prices.
When the market crashed in 1989, and continued lower all the way into 2009 (albeit with many false rallies and vicious whip saws), household and business balance sheets were in severe shape. Liquidity was quite a dilemma.
Under such circumstances, the private sector naturally retrenched by scaling back spending. Yet, despite decades of balance sheet stress, low private sector spending, accompanied by an aging population, Japan has managed to maintain a remarkably high level of employment.
How have they achieved this? A simple housing shock, nowhere near as dramatic as the Japanese stock market debacle, pushed our unemployment to highs not seen since the 1930s. The spill-over effects in Europe have created depression-level unemployment in Greece, Portugal, and Spain.
What path have our foreign friends in the Far East pursued to arrest the unemployment which quite rightly could have and should have prevailed for the past 25 years? The answer is simple. If households and businesses will not spend at a level consistent with full employment, then the government will. That has been their approach.
How did they implement the strategy, and how has it worked out? The first question is simple. The government produced many goods and services, such as healthcare, which we relegate to the private sector. Much of the government spending has been carried out through deficit financing. That is, the government has kept taxes low but spending high for decades.
Is this not a prescription for disaster? When a national government spends well above its tax receipts for many years, causing its debt to mushroom, will this not lead to inflation and soaring interest rates? We have now reached the point of repetition in learning.
Recall that a government is not a household. Nor is a business a government. The government is a whole sector of an economy. As such, the economic rules which apply to a government differ in many material ways from those which envelope prudential household finance.
If an individual household or business runs a constant deficit, debt will rapidly rise to a point of insolvency. The Japanese government experience has taught the world an important contrasting lesson regarding the role of the government sector as well as the consequences of deficit financing. In fact, their performance has confirmed much of the theoretical knowledge first proposed by a handful of economists following the Great Depression.
In short, the Japanese have shown that when the private sector chooses to spend money on goods and services at levels inconsistent with full employment, the government sector can make up the difference through deficit financing, thereby putting people back to work. Further, such debt-financed spending can go on for decades without any rise in inflation or interest rates if the shortfall in private spending continues.
What are the numbers like? During the past 25 years, consumer inflation in Japan has averaged just under half of one percent per year (versus over three percent in the U.S.). Yet the government debt as a percent of annual gross domestic product has risen from about 70 percent to over 240 percent and rising.
To put this into perspective, when the US debt to GDP ratio recently touched 100 percent, a portion of the press treated it as a national disgrace and disaster. Have Japanese interest rates soared as a consequence of this explosion of government debt? No. The 10-year government bond yield is around half of a percent at the moment, less than a fourth of our borrowing cost.
To repeat, Japan has proven that it is possible to run enormous government deficits for decades without high inflation or high interest rates. This is what Keynes, Hicks, Samuelson, and others tried to explain to the world back in the 1930s and ’40s. This is what economists of my generation were taught in grad school.
At that time it was only theory, albeit very reasonable theory, but now, after 25 years of practice in the Japan, we have empirical evidence to back up the theory.
What is the significance of this? Why do we care what has happened in Japan, and will the next generation of Japanese be burdened with a truckload of debt? We will examine these questions next week.
(Marcus Hutchins, MA, M. Phil, Economics, Columbia University, NYC, is a former economist, treasury bond arbitrage trader and hedge fund manager. He retired to Southport in 1997 where he resides with his wife Andrea and his youngest daughter Abbey. He welcomes feedback at coastaleconomist@me.com.)
