The land of the setting sun
So now we know why the Bank of Japan has increased its QE
programme, and why Shinzo Abe was dithering about raising the sales tax again –
and why he is calling an election. Japan is officially in recession. Annualised
GDP growth has fallen by a further 1.6%, on top of a 7.3% fall in the previous
quarter. Analysts attribute this to the effect of the previous sales tax rise. Clearly no-one will want to raise it again any time soon.
According to the New York Times, this quarter’s GDP fall was “unexpected”. But why should anyone be surprised that consumption tax rises have contractionary effects? It seems blindingly obvious to me that raising consumption taxes would cause sales to fall. Japan’s recession is entirely understandable.
However, some in the econosphere seem to think that when inflation is very low, retail price rises always have a beneficial effect, whatever their cause. The thinking seems to be that higher retail price inflation due to tax rises would force employers to raise wages, so rational people should not be deterred from spending. Of course Japan does have a high proportion of people on fixed incomes, but raising the headline inflation rate should enable interest rates to rise, which would benefit them. So raising prices by means of consumption tax hikes is a good idea, apparently. Improve your public finances, get your inflation rate up and encourage wages to rise. What could possibly go wrong?
There are serious problems with this line of thinking. The first, and most obvious, is that price rises due to sales tax increases do not increase the profits of retailers or manufacturers. They are therefore not likely to want to increase wages in response to a tax-led price increase. Is the Japanese labour market sufficiently tight to force them to do so? On the face of it, it should be - after all, Japanese unemployment is amazingly low, at only 3.6%. But this is the performance of Japanese wages over the last 10 years:
There is obviously a lot of seasonal variation in this chart, but the overall trend is pretty clear. Despite low unemployment, Japanese wages have been stagnant for the last 10 years. I can’t see why a sales tax increase would suddenly bring them to life when successive monetary and fiscal easing programmes have failed to do so.
But even if wages were to rise, there is the “money illusion” problem – and the well-known preference of ageing Japanese households for saving over spending. So, Mrs. Watanabe sees prices rising in the shops. Does she increase spending to match? Not if she can help it. Complaining about inflation, she substitutes cheaper products or cancels purchases. Meanwhile Mrs. Watanabe’s husband gets a pay rise. Does she spend that money? No, she does not. She saves it for their retirement.
So a sales tax rise raises inflation, but consumption spending falls, the economy slips into recession and tax revenues fall, making the government’s fiscal position even more precarious. Tax rises are contractionary. Always.
Sometimes contractionary tax rises are unavoidable because of the risk of a buyer’s strike and sovereign default, as has happened in the Eurozone. But Japan is not Greece. Yes, its debt/GDP is by far the highest in the world, and the latest GDP figures don’t exactly help matters. But much of its debt is the savings of its own people, and an increasing proportion of it is held by the central bank. As I’ve explained before, when a central bank stands ready to buy its own government debt, it effectively sets a floor under the price of that debt, preventing a buyer’s strike and eliminating the risk of sovereign default. So as long as the Japanese central bank is ready to buy unlimited quantities of Japanese government debt, there can be no price collapse.
Some worry that the end game for Japan will not be sovereign debt default but hyperinflation. This seems weird for a country that has been suffering deflation for decades. But the Japanese central bank is buying government debt at an unprecedented rate, flooding the Japanese banking system with reserves. Hyperinflation is a domestic, not an international, phenomenon: it occurs when the people of a country collectively refuse to use its currency. Is it at all likely that Mrs. Watanabe, spooked by all this monetary base creation, will reject the yen and start using other currencies, or even gold, instead?
No. It is not remotely likely. And the reason – again - is Japan’s ageing population and high saving rate. Mrs. Watanabe isn’t getting any younger, and her retirement savings are virtually entirely in yen-denominated Japanese debt and equities. Rejecting the yen would wipe out her savings. How on earth would this be in her interests?
However, the disappointing GDP figures are not quite what they seem. A considerable reason for Japan’s difficulty raising GDP is the fact that its population is increasingly well-off. GDP may be on the floor, but GDP per capita looks rather good:
Why on earth would the Japanese want to work more? They
are quite comfortable as they are, thank you. And why should government force
them to work more? The median age in Japan is over 44 and rising. Japanese already
work well into their 60s and often for much longer. Elderly Japanese are
increasingly involved in looking after even more elderly Japanese as well as
the dwindling number of grandchildren. They contribute to the economy in
numerous ways, most of which are not recorded in official GDP figures. Cutting
their standard of living to force them to work more might raise GDP, but it
would not make them more prosperous. It would simply replace unpaid
contributions with paid ones. Measures of GDP are deeply inadequate in all
economies, but particularly so in Japan.
There is an additional problem, too. Forcing the population to do more paid work might improve the government’s fiscal position, but it would discourage the considerable steps Japan is taking towards automation of both production and services. For an ageing population, the more automation the better. After all, as time goes on people will need to do less work, not more. Of course, robots don’t spend money, and they don’t pay taxes, so GDP will remain low and the government’s fiscal position precarious. But there is a solution, of course. Nationalisation. Not directly, but via state pension funds. The Japanese government pension fund is now buying Japanese equities in large quantities. Clearly, if most Japanese households have savings in government and private pension funds, and those pension funds own the means of production, there will be a reasonably equitable distribution of returns. And if the central bank owns a substantial proportion of government and private sector assets too – and is ready to buy more – then the government’s fiscal position is only precarious to the extent that future production is precarious. Japan needs automation. It relieves the precarity caused by an ageing population.
As long as the central bank and government institutions protect savings by standing ready to buy not only government debt but private sector assets too, Japanese households will remain comfortable. Older workers will put up with stagnant wages as long as their jobs are secure: young things whose jobs are insecure will aspire to job security rather than higher wages (I think we are seeing this in Western economies too), and as the oldies retire they will gradually take over their secure jobs. Japan’s economy is largely closed to immigrants for cultural reasons, though we will see a rising proportion of Japanese women in the workforce due to demand for their skills. But there is not going to be massive liberalisation of the labour market, because people will trade higher wages for security. There is not going to be a sudden debt deflationary collapse, because that is in no-one’s interests. There is not going to be sudden rejection of the yen, for the same reason. When the sun is setting, no-one wants to do anything dramatic. Perhaps it is time for the Japanese government to stop trying to kick its elderly economy into growth, and accept that comfortable retirement is what people want.
And perhaps it is also time to stop worrying about the Japanese fiscal position. Japan is currently running a small trade deficit, but if the high saving preference of Japanese households is to be accommodated, its government must also run a fiscal deficit. Trying to cut this by means of tax rises is counterproductive. However, even without a further sales tax rise, the fiscal deficit may eventually sort itself out as the proportion of the Japanese population actively saving declines. After all, the elderly don't save, they spend.
But dis-saving by the elderly may force Japan to monetize its debt. And monetizing government debt means breaking a global taboo. Scarred by the experiences of Weimar and Zimbabwe (among others), where hyperinflation was associated with monetization of debt, the world is convinced that monetization of debt will always lead to disaster.
We rightly fear monetization of debt by a distressed sovereign shut out of markets and desperately trying to meet its obligations. But that is not what Japan faces. It is difficult to see how gradual monetization of debt to meet the dis-saving needs of an ageing population could possibly trigger hyperinflation. For an elderly population that has built up substantial savings in the form of government debt, knowing that there will always be a buyer for that debt is a huge relief. After all, the interest on their savings is never going to be enough to live on. The yield on the 10-year JGB is below 0.5% and falling. Japanese households are hardly going to reject the yen when the central bank is monetizing their savings in order to provide them with the means to live.
For countries with ageing populations, stagnation and low inflation are benign forces that should not be resisted. The countries of the old are places of calm and stability, not frenetic activity and fast growth. And in the sunset of a civilization, debt monetization may be a friend.
Rethinking the monetization taboo - Adair Turner
Image from Pictures4Eva.