Things That Make You Go Hmmm...
November 25, 2013
"It's unfortunate that there are people who tout the mostly unfounded fears of hyperinflation."
"Living in a world such as this is like dancing on a live volcano."
"Japan likewise put her hopes of victory on a different basis from that prevalent in the United States.... Even when she was winning, her civilian statesmen, her High Command, and her soldiers repeated that this was no contest between armaments; it was a pitting of our faith in things against their faith in spirit."
"There are no bad ideas, Lemon, only great ideas that go horribly wrong."
"The miserable have no other medicine
But only hope."
In 1853 the French romantic composer Charles Gounod wrote a melody that was especially designed to sit over the Prelude No. 1 in C Major written by Johann Sebastian Bach over a century earlier. He titled it (somewhat unimaginatively, perhaps) "Meditation sur le Premier Prelude de Piano de S. Bach."
Interestingly enough, Gounod's father-in-law, the magnificently named Pierre-Joseph-Guillaume Zimmerman, transcribed the improvised melody and arranged it for violin, piano, and harmonium; and thus a piece that Gonoud himself never actually wrote down went on to become one of the most-recorded and most-played pieces of music in the history of mankind.
It was the addition by Jacques Leopold Heugel in 1859 of the words from the Latin text of the prayer Ave Maria that put Gonoud's noodlings on the road to ubiquity at church ceremonies throughout the Christian world.
Ave Maria is of course a traditional Christian prayer that asks for the intercession of the Virgin Mary in one's life, to deal with any number of tricky situations that may arise and leave the supplicant feeling as though divine intervention is the only solution.
The Ave Maria is more commonly known to most people by its English translation: Hail Mary.
As the last refuge of the hopeless, the Hail Mary has also taken its place in the sporting lexicon over the years, particularly in American football, where it was popularized through the play of two members of the fabled Four Horsemen (Notre Dame's legendary 1924 backfield, consisting of Don Miller, Harry Stuhldreher, Elmer Layden, and Jim Crowley) in an era when sports reporters such as Grantland Rice (who brought the Hail Mary to the gridiron) were capable of prose seldom seen on the sports pages today.
Exhibit A is the lead for the piece in which Rice introduced the Hail Mary in October 1924, after Notre Dame upset a heavily favoured Army team:
Outlined against a blue-gray October sky, the Four Horsemen rode again. In dramatic lore their names are Death, Destruction, Pestilence and Famine. But those are aliases. Their real names are Stuhldreher, Crowley, Miller and Layden.
They formed the crest of the South Bend cyclone before which another fighting Army team was swept over the precipice at the Polo Grounds yesterday afternoon as 55,000 spectators peered down upon the bewildering panorama spread out on the green plain below.
Exhibit B is the opening paragraph from a NY Post recounting of a NY Jets loss to the Buffalo Bills:
The Jets brought Ed Reed in on Thursday to help a leaky pass defense, one that has proven vulnerable to the deep ball.
But despite being shoehorned right into the lineup, the future Hall of Famer couldn't keep that Achilles' heel from being exposed over and over in a 37-14 loss to the Bills.
Call me old-fashioned, but where are the modern-day Grantland Rices? (Or is the plural "Grantlands Rice"? I don't know.)
But I digress.
The definition of the term Hail Mary as it pertains to football, provided here by Wikipedia, does a sterling job of setting the stage for this week's topic:
A Hail Mary pass or Hail Mary route is a very long forward pass in American football, made in desperation with only a small chance of success, especially at or near the end of a half.
Yes, the Hail Mary is used in desperation, near the end of a contest when there is only a small chance of success...
When Abenomics was unveiled in Japan upon the re-election of Shinzo Abe as prime minister in late 2012, it is safe to say that, having been mired in a 20-year deflationary spiral and with debt totaling 240% of GDP, Japan was nearing an endgame of sorts.
For two decades the country had watched the yen strengthen and endemic deflation thwart any and all attempts to generate even moderate inflation, as repeated bouts of quantitative easing failed to administer the desired antidote to Japan's ever-increasing debtload.
Realizing just how late in the game he found himself, Abe promised to change all this, but in order to do so he needed to pursue a high-risk strategy with a low probability of success.
The press (ever hungry for a new, catchy portmanteau word) dubbed it "Abenomics."
Personally, I prefer to call it "Avenomics": the economics of the hopeless.
Abe's opening (and perhaps his most important) gambit was the politicization of the Bank of Japan. Without a complicit governor quarterbacking Japan's printing press, any attempt at reaching the endzone would be futile.
Whilst campaigning for office, Abe took verbal swipes at incumbent BoJ president Masaaki Shirakawa, criticizing him for failing to do enough to lift Japan out of its deflationary malaise, but Shirakawa stood firm:
(Japan Times, November 2012): Bank of Japan Gov. Masaaki Shirakawa pushed back Tuesday against pressure on the central bank, criticizing the unlimited easing advocated by opposition leader Shinzo Abe and urging respect for the BOJ's independence.
"I seek respect for the BOJ's independence as it's doing its utmost to conduct appropriate monetary policy," Shirakawa said.
Without naming Abe, Shirakawa said that unlimited money-printing could worsen the national debt and that a 3 percent inflation goal, also suggested by the head of the Liberal Democratic Party, would be unrealistic.
Abe's opponents were quick to point out a few minor problems with his raft of promises:
Cabinet ministers criticized recent remarks by Abe, saying direct financing of the government by the BOJ could destabilize the economy and would threaten the bank's independence.
"That would be off limits," Finance Minister Koriki Jojima told reporters after Abe, head of the Liberal Democratic Party, said the BOJ should purchase government bonds to finance public works projects to boost the flagging economy.
"It would weaken fiscal discipline, trigger a surge in interest rates and cause excessive inflationary pressure," Jojima said.
But, of course, in this day and age such fiscal and monetary prudence was unacceptable; and the idea of money printing to solve the problems, as opposed to the collective tightening of belts, was just irresistible (particularly when all the other cool kids were printing), so Abe won in a landslide.
Once installed in the Sōri Daijin Kantei (official residence of the Japanese prime minister), Abe went right to work, and job one was to get rid of Shirakawa:
(WSJ, December 2012): It is scarcely a secret that Shinzo Abe, who will become Japan's prime minister this week, hasn't much time for Masaaki Shirakawa, governor of the Bank of Japan. Abe has already said he will replace Shirakawa when the central banker's term of office expires in April. In the meantime he is threatening to resort to law to get Shirakawa to adopt the 2% inflation target Abe has been championing in an attempt to inflate the Japanese economy back into growth.
Shirakawa has led the Bank with extreme caution. He has not embraced aggressive monetary policy to the extent of his counterparts in the other large economies. Last week he announced an expansion of the Bank's asset buying program to 91 trillion yen ($1.1 trillion) but ignored Abe's calls for a 2% inflation target.
All too little, too late, in Abe's view.
In short, Shirakawa's refusal to crank up the presses to warp speed wasn't satisfactory to Abe, so he had to go.
Abe knew exactly who his preferred candidate was, and he kept up the pressure on Shirakawa even as he basked in the glow of his election victory.
Eventually, Shirakawa had enough:
(Bloomberg): Bank of Japan Governor Masaaki Shirakawa will step down on March 19, almost three weeks before his term was due, accelerating a leadership transition that may aid Prime Minister Shinzo Abe's campaign for aggressive easing.
Shirakawa, 63, will exit the same day as two deputy governors, he told reporters in Tokyo yesterday. He was scheduled to leave on April 8....
"It's the equivalent of waving a white flag for unconditional surrender," said Shuichi Obata, senior economist at Nomura Securities Co. in Tokyo. "Shirakawa didn't share the government's view that the central bank is responsible for ending deflation."
In true Japanese style, however, on his way out of the revolving door at the Bank of Japan, Shirakawa declined to lay blame and made sure the drama was minimized:
"There was no pressure at all from the government, this was my own decision," Shirakawa told reporters last night after a meeting with Abe, saying it was not an act of protest. He said he made the decision yesterday so that the central bank's new leadership could start together.
Number of people fooled? Zero.
Into the void created by Shirakawa's premature evacuation stepped none other than Abe's preferred candidate, Haruhiko Kuroda, who also wasted no time in getting to work:
(Japan Times): Bank of Japan Gov. Haruhiko Kuroda on Thursday revealed his strategy for ending more than a decade of deflation by expanding the central bank's purchases of government bonds and allowing it to buy riskier assets.
The bank will "enter a new phase of monetary easing in terms of quantity and quality," Kuroda said in explaining that the moves will double Japan's monetary base and the amount of outstanding Japanese government bonds and exchange-traded funds within two years.
"This is coming from a different level in both quality and quantity," Kuroda told reporters after the two-day Policy Board meeting. "We have put forward everything there is to do at this point," he said.
The rest, until recently, anyway, is well-documented.
The yen fell...
The Nikkei soared (kinda, though not without testing a few nerves along the way)...
And Japanese government bond prices? Well, unfortunately, they did what they OUGHT to do in a situation where investors are being promised 2% inflation: they fell off a cliff...
However, the BoJ's massive bond-buying program countered that trend (for the time being), and though it looks as if the JGB market is well and truly on its way to running out control, the BoJ once again has the upper hand. Sort of. For now.
Central to Abe's problem of somehow finding a way to generate the required inflation, however, is the malaise in Japanese wages, a problem that has beset the country for many years.
Source: Japan Ministry of Health, Labour & Welfare
The wages issue has meant that the problems facing Abe and his new lackey BoJ governor are as much psychological as fiscal or monetary, since entrenched expectations of stagnant wages and falling prices have led Japan's citizens into a rather unfortunate mindset:
(Bloomberg, January 2013): More than 80 percent of respondents in a Bank of Japan survey released this month who noticed rising prices last year said it was bad. More than a third of those who said prices fell were happy about it.
After two decades of persistent deflation, Japanese households have modified their behaviour — to the point where they now hold more tan half of their savings in cash.
Source: Bank of Japan
The other casualty, as far as the BoJ is concerned, is the net change in the bond holdings of the famed "Mrs. Watanabe," which have fallen materially for eight straight quarters, as can be seen in the chart below. Cash deposits (in red) are the only asset that has risen in each of the periods represented, whilst bond holdings (in blue) are the only asset that has declined in each quarter. Also noticeable is the sharp increase in equity holdings (in green) since the Japanese people were "promised" higher equity prices.
Hey! This Avenomics thing is easy.
Source: Bank of Japan
The current allocation of Japanese household assets, when viewed as a pie chart, speaks a thousand words as to the mindset of the Japanese citizen — and the motives behind Avenomics:
Source: Bank of Japan
But let's get back to that whole "wages" thing and a former BoJ official's thoughts on the subject:
(Bloomberg, Jan 2013): "The key is wages," said Nobuyasu Atago, principal economist at the Japan Center for Economic Research and a former BOJ official in charge of price data. "Without pay increases, the economy won't recover and households will only suffer from inflation."
Japan's main business lobby signaled it won't endorse pay rises at regular wage negotiations with labor unions this spring, Kyodo News reported Dec. 20. Prime Minister Shinzo Abe's Liberal Democratic Party is considering tax breaks for companies that raise pay or expand hiring.
Indeed. The key is wages. Unless they rise, Avenomics is DoA, so I was very surprised at an article I read a few weeks back that received scant coverage and, amazingly, even less commentary.
First, to set the scene, a little history on a company called Chubu Electric Power:
The company, founded in 1951, is an electric utilities provider for central Chubu on the main Japanese island of Honshu. It has 199 generating stations with a total capacity of 32,473 MW, of which 183 are hydro-electric generating stations, 12 are thermal power stations, and making up the total are 1 wind and 2 solar stations as well as the company's lone nuclear power plant, which was shut down in May 2011 on government instructions after the Fukushima tragedy.
Chubu Electric employs 17,345 people and is one of the "Big 4" Nagoya-based companies (alongside Meitetsu, Matsuzakaya, and Toho Gas).
In short, Chubu Electric Power ain't a small business.
So with that as background, let's get to the article:
(Kyodo News, October 22, 2013): Chubu Electric Power Co. plans to cut its workers' wages by around 20 percent from April in a bid to gain customer approval for raising electricity rates from that month, sources close to the utility said Tuesday.
It presented to its labor union Tuesday a plan to reduce unionized employees' basic wages by around 5 percent, halve their summer bonuses and cut other allowances, the sources said.
The planned cut of basic wages will be the first since the company's founding in 1951.
(Japan Times, October 22, 2013): Chubu Electric Power Co. called on its labor union Tuesday to accept a 20 percent cut, excluding overtime, in the year starting next April.
The steep salary cut is designed to win public understanding for when the company seeks government approval for a full-fledged increase in electricity charges for household users beginning in April.
As part of the pay cut, the monthly basic salary would be reduced by 5 percent, the first wage cut since the firm was launched in 1951.
Summer bonuses would be halved from last year to the equivalent of one month of basic salary. Winter bonus levels have yet to be determined.
The company will carry out an even steeper pay cut for managers.
Yep, you heard right.
The Japan Times, however, went further:
Chubu Electric has had to deal with soaring fuel costs for thermal power plants since it halted its Hamaoka nuclear power station in Omaezaki, Shizuoka Prefecture, in May 2011 at the request of the government.
Fuel costs for the year ending next March are expected to total ¥1.25 trillion, 1.8 times the level prior to the suspension of the Hamaoka plant. The company may incur a third consecutive annual net loss this year.
"Soaring fuel costs" — since the shutting of its lone nuclear facility.
Exactly a week after announcing the proposed wage cut, Chubu played their second card:
(Japan Times): Chubu Electric Power Co. made it official Tuesday and applied for approval to raise household electricity fees, the seventh utility to seek higher rates amid the nuclear shutdown caused by the Fukushima disaster.
In its request filed with the Ministry of Economy, Trade and Industry, Chubu Electric Power said it wants to raise electricity prices for households by an average of 4.95 percent next April 1.
The utility, which covers the Nagoya region, is already planning to raise rates for corporate customers by an average of 8.44 percent. This increase, which does not need government approval, also takes effect April 1.
And there, in two press announcements from one company within a seven-day window, is the problem facing both Japan in general and Avenomics in particular: stagnant (or falling) wages and a cost of living that is rising exactly as Abe promised.
So let's recap:
Since Fukushima, oil as a percentage of Japan's energy consumption has doubled, consumption of LNG has almost doubled, and nuclear power has declined to essentially zero.
The huge shift is due to the fact that whilst all of Japan's nuclear power was generated domestically, it is a different story for oil and LNG, as Japan is the world's third-largest importer of oil (behind the US and China) and the world's largest importer of LNG.
The energy picture looks horrible, of course, when put up next to the "success" of Avenomics with regard to the yen.
First up, Brent Crude priced in US dollars:
So, since the Fukushima disaster in March 2011, there has been a reasonable 5% decline in one of the most basic components of global inflation. Not great for Abe's drive to generate inflation, but undoubtedly a good thing for the citizens of Japan.
Next up, the same commodity priced in yen:
For those of you keeping score at home, that's a 16% increase in the price of oil to the Japanese consumer.
Inflation! Bravo! Avenomics is a roaring success.
I bring up the energy example to show the flip-side of Avenomics with regard to a commodity upon which Japan is almost totally reliant, but the really important thing is the proposed wage cut by Chubu.
The Japanese government hopes to promote wage hikes needed to help generate the inflation it deems necessary, yet one of its largest utility companies is simultaneously proposing to CUT wages by TWENTY PERCENT (think, for a moment, about the reaction that would meet with in the US ... or France!) and hike the cost of what they produce — something everybody in Japan consumes — by between 5 and 8%.
Avenomics was built around a "three-arrow" economic plan that was lauded as visionary and daring. Many thought it would generate the sort of shock and awe (oh how I've grown to hate that phrase) needed to guarantee Japan's exit from its long slump.
The first arrow was a ¥10.3 trillion fiscal stimulus program that would increase public spending (well, that's just more freshly printed cash).
The second arrow was (believe it or not) yet more easing of monetary policy in order to increase investment, demand, and of course inflation.
Then there was that third arrow: structural reforms.
Together these initiatives were supposed to increase incomes as well as Japan's competitiveness and productivity and bring the higher wages that are an integral part of of Avenomics.
Now I will happily admit that on paper Avenomics is a thing of beauty. I mean, what's not to love? Wages go up, prices go up (less than wages, ideally), the yen weakens, exports increase, Japan Inc. gets back on its feet, and Japan's debt is gently inflated away. Everything gets fixed, and Japan can once more hold its head up high. Hey, I'd vote for that!
Dammit, we've been here before, and for an eloquent summation of the futility inherent in pressing the same button over and over again, I shall cede the floor to my friend Satyajit Das:
The government's spending program follows 15 stimulus packages between 1990 and 2008. Based on previous experience, it may provide a short-lived boost to economic activity but will not create a sustainable recovery in demand.
Investment will be mainly in non-tradable, non-competitive sectors like public infrastructure and construction, frequently adding to over-capacity and earning poor returns. The OECD recently identified the inefficient and ultimately wasted investment that characterized previous packages.
Japan has maintained a zero interest rate policy ("ZIRP") for over 15 years and implemented several rounds of QE. The new plan will assist the Japanese government to finance its spending. It may also help devalue the Yen and boost asset prices. But given that short term rates were near zero and 10 year rates around 0.50% before the announcement of the plan, the effect of monetary initiatives on real economic activity are likely to be less significant.
Structural reform requires deregulation of inefficient sectors of economy, opening them up to domestic and foreign competition. Reform is needed of taxation, trade policy, labor markets, environmental laws, energy policy, healthcare, services as well as population and immigration.
Many "reforms" are vague statements of objectives. Many of the ideas are old. Many policies have been tried before unsuccessfully. The required changes are also politically and culturally difficult.
Aha, that third arrow! "Culturally difficult." I'll say.
Avenomics relies on two very familiar things: Hope and Change.
The hope is that Japan can make all these bold moves without encountering any resistance and without any of the countries Avenomics will affect (think Korea and China) taking countermeasures.
The change? Well that's a whole other matter, I'm afraid.
The Japanese do NOT like change (something I saw up close during my three-year stay in that beautiful country in the late 1980s/early 1990s at the peak of the bubble and in its early aftermath), and they like BIG changes like those required by Avenomics even less. Nowhere is that more obvious than in the case of Japanese demographics — one of the country's two biggest hurdles.
Japan's aging population hasn't suddenly snuck up on anybody — the situation they are in now is exactly where they were projected to be a quarter of a century ago when I lived there. But back then, the demography curve facing Japan was something to be worried about another day.
Well, guess what? That day has arrived, and in the intervening time nothing has been done to address Japan's chronic demographic problem.
Now it's too late.
Japanese births have been falling for 40 years:
The net result? Horrible:
Source: Japan Ministry of Internal Affairs/Washington Post
The solution WOULD have been to start relaxing immigration laws decades ago, but there we run into that little problem of cultural unwillingness to make major changes. And so, because of strict adherence to deeply rooted cultural norms, Japan has attained the condition that the Germans so tenderly call "schrumpfende Gesellschaft" — a "shrinking society."
Amazingly, in a country that boasts a population of 127,650,000 (according to 2012 census estimates), there are barely more than 2 million foreigners resident in Japan — an extraordinarily low 1.6%.
In the USA that number is 13%.
Want some more amazing facts about Japan's demographic nightmare? Well, try these on for size (courtesy of the US Census Bureau projections and Nicholas Eberstadt):
By 2040, the ratio of newborns to centenarians in Japan will be roughly 1:1.
Over 75% of the people who will make up the population of Japan in 2040 are already alive today.
In 2008, 40% percent as many Japanese babies were born as in 1948.
If current projections come to pass, Japan will not have many more newborns in 2050 than it did in the 1870s.
By 2040, more than a third of Japanese will be 65 or older.
Japan is already the world's grayest society, with a median age of almost 45 years.
By 2040 the median age in Japan will rise to an almost inconceivable 55. (By way of comparison, the median age in the retirement haven of Palm Springs, California, is currently under 52 years.)
And finally, in case you didn't get the joke yet, by the country's own projections, Japan's population will decline from about 127 million today — making it the 10th most populous country in the world — to about 106 million in 2040.
The working-age population (ages 15–64) will plunge 30 percent, from 81 million to 57 million.
In 2040, by these projections, the total population will be declining by about one percent annually (roughly one million people per year) and the working-age population by almost two percent annually.
Got it? Trouble.
Demographically speaking, Avenomics is in need of divine intervention.
Then there's the other "D" facing Japan, the one EVERYBODY has heard about: debt.
Back to Das for a succinct recap:
Japan is one of the most heavily indebted developed countries. Its total debt to GDP is over 500%, compared to the US's 370%.
Japanese gross sovereign debt is around 240% of GDP, while its net debt is around 135%, substantially higher than most developed countries. The government borrows to finance over 50% of its spending.
Japanese gross sovereign debt is around 240% of GDP, while its net debt is around 135%, substantially higher than most developed countries. The government borrows to finance over 50% of its spending.
Then there's that magic number that Japan breached this past summer when its public debt hit ¥1 quadrillion.
That number, hard to picture, looks like this:
Or, as I pointed out in a recent presentation, if you wanted to count to a quadrillion ... it would take you 31,709,792 years.
That's a hell of an IOU to run up.
So the reason why Abe desperately needs inflation is clear; but let's face it, 2% ain't gonna do the trick.
The government needs higher inflation than that (something an aging population living on fixed incomes will not be happy about, once they figure it out) — and revenue.
Hiking the consumption tax from 5% to 8% is a start, and the planned rise to 10% in 2015 is another step in the right direction; but, like everything in Japan, that further rise is "dependent upon economic conditions," and those are not exactly rosy, I'm afraid.
Couple the outrageous level of debt, the declining population, the stagnant wages, and the rising cost of living with Japan's plummeting savings rate...
... and you can clearly see just how far the clock has run down on Shinzo Abe.
So here he is — Japan's great hope — with time about to expire and the pressure mounting.
Facing the rush of a moribund economy, entrenched price deflation, an aging demographic that has drawn down its savings and actually likes the idea of lower prices, and a debt mountain that eclipses that of every other major economy on earth, is it any wonder that Abe-san has decided to hurl the ball into the endzone and hope that a helpful pair of hands hauls it in for a TD?
Of course, popular thinking goes that, since Japan has been doing the constant-stimulus thing for two decades without any noticeable consequences, all will be well; but the problem lies in the fact that, throughout the nineties and noughties, Japan was basically scrimmaging on its own practice field — alone, behind closed doors.
Now they find themselves in a competitive game with every other major economy in the world suited up and also needing higher inflation, weaker currencies, and genuine growth after littering the field with trillions in stimulus.
Say a prayer for Shinzo Abe, folks. For Avenomics to score, he's gonna need a miracle.