Michael Roberts. Japan: caught between inflation and slump

 Japan: caught between inflation and slump

by Michael Roberts.

Back last February, I posted about the state of the Japanese economy when Sanai Takaichi, Japan’s first female prime minister called a snap general election, which she won in a landslide.  Takaichi, who models her views on Britain’s Margaret Thatcher of the 1980s and now on Trumpism, claimed she would be different from all past prime ministers.  She would cut taxes, in particular, the consumption tax which drives up prices in the shops, but at the same time increase government spending on social security and ‘defence’, even if it meant higher budget deficits. Takaichi was ‘going for growth’ in a not dissimilar way as the ill-fated, short-lived British Conservative prime minister, Liz Truss. Truss’s plans for big rises in the UK budget deficit led to a sharp rise in UK government bond yields and a run on the pound. She lasted just over a month before ‘the powers that be’ (the bond markets) got her ousted.

Last February, I forecast that something similar would happen in Japan, if at a slow burn. And now it has come to pass.  Japanese government bond yields have rocketed to highs

While the Japanese  yen has collapsed to near historic lows.

The problem for Japan is that economic expansion has increasingly depended on permanent government deficits, with government spending on construction and other projects; and yet Japan’s economy has continued to stagnate. With Japan’s corporate sector unwilling or unable to invest, Takaichi has been attempting to end Japan’s stagnation by yet more spending on projects to boost technology, while telling the Bank of Japan to not raise interest rates, as servicing existing government debt is already using up a quarter of all government spending! This Truss-Trump type policy has got the Bank of Japan and the financial institutions really worried, as well as foreign investors.

As I said last February, the Japanese economy has now morphed into stagflation, with rising prices, flat GDP and consumer spending and falling real wages.  Consumer prices have risen 12% since 2021. At the same time, real GDP is barely higher than it was in 2018. Real wages are down 7% from their 2018 level.  

Takaichi’s policies won’t end up crashing the Japanese government bond market as Liz Truss managed in the UK.  That’s because most Japanese government debt is held by Japanese (88%), unlike in the UK. The risk of capital flight only lies in that portion held by private investors, the net debt. And the latter is smaller than it’s been in decades, mainly because the BoJ has bought so much of the debt since 2013.

Instead, it is the currency that is diving. With a 50% depreciation of the yen since 2021 to its lowest rate for 40 years.  Far from delivering a kick-start to economic growth and exports, the fall in the yen has just accelerated inflation. The inflation rate is heading to 3% a year, unheard before of in Japan.

In the last week, the fall in the yen eventually prompted the Bank of Japan to intervene and start buying yen with its dollar reserves. But the new development was that US Treasury also came to the aid of the BoJ and Takaichi by starting to buy yen.  This has helped to stop the depreciation of the currency, at least for now. 

The US entered the fray for two reasons.  First, the US Treasury Secretary Scott Bessent was concerned that the fast rise in Japanese government bond yields (2.86% in July, its highest level in some 30 years) would also lead a further rise in US government bond yields, already at highs.  The cost of servicing US government debt would rise and other interest rates in the US, like mortgage rates would move up.  US government borrowing costs are now at around 4.6 per cent, and 30-year bond rates are north of 5 per cent for the first time since the great financial crisis.

Rising interest rates are not popular with American households, where inflation is also on the rise, the jobs market is stalling and real incomes are stagnating at best.

The other reason for the US intervention was that a weak yen would lead to an accelerated flow out of yen by financial investors and into buying US dollars. This would strengthen the dollar and so make US exports even more difficult to compete in world markets. But what was odd about the US intervention was the US treasury used euros to buy yen, not dollars. This suggests that the US government is now reluctant to print more dollars because foreign investors have to some extent lost their enthusiasm for dollar assets, at least for US government bonds. It’s a sign of a weakening of US dollar’s ‘exorbitant privilege’ in world financial markets.

What can we learn from these currency events? First and foremost, that all roads are now leading to ‘stagflation’, where inflation rises, but economies do not expand.  This is the story for Japan, Europe and even the US.  Second, that pro-business governments cannot stimulate growth through currency depreciation or through trying to keep interest rates low if capitalist companies won’t invest. Japan’s corporations may have increased profits at the expense of wages, but they are not investing that extra capital in new technology and productivity-enhancing equipment.  

The current yen crisis could only be resolved by a sharp rise in Japanese interest rates to encourage investors to hold Japanese financial assets. But this would ensure an outright recession in the Japanese economy. Takaichi is caught in a trap between inflation and slump.