“We all know what to do, we just don’t know how to get re-elected after we have done it” Jean-Claude Juncker, Prime Minister of Luxembourg
As we have discussed, Quantitative Easing—QE—by central banks does not stimulate the economy by leading banks to boost lending (see Part 1) and does not fight deflation (see Part 2). This is hardly heresy: the Bank of Japan itself said “quantitative easing … is not effective” in a 2001 journal of monetary and economic studies. Why doesn’t the Abe government ignore in favor of implementing programs that would more effectively combat Japan’s seemingly endless recession?
To answer, we must first ask what a recession is? I would define it as a period of economic contraction and dislocation caused by the excesses of prior periods. Extreme expansions are caused by booms—Japan’s include property in the 1980s and internet around 2000—which grow to excess and are followed by busts during which those excesses are worked out. The working out process is usually painful, like the spike in Silicon Valley unemployment after the internet bubble burst or the” see through” buildings in the Texas after the oil/S&L bubbles burst. The fastest way to get through the bubble may be to let it fully and thoroughly burst and then assist the distressed in dealing with the consequences.
The pain associated with a thorough burst, though, is so politically unpopular that admitting you will let it run its course could be political suicide. Instead, they try to combat it with actions like bailing out high profile companies, slashing interest rates, propping up land and equity prices, scapegoating short sellers, fudging accounting standards.
Ultimately these actions seldom accomplish more than delaying the manure’s contact with the ventilator. Government action could no more fully utilize the fiber optic capacity built a decade ago than the excess railroad capacity built in the 19th century. America’s Chrysler bailout rescued neither the company nor the industry, which demanded a more comprehensive bailout less than 30 years later. (Although that bailout, popular is several swing states, gave Obama his second term). Japan’s supplemental budgets didn’t produce nominal growth any more than its gimmicks for obscuring non-performing loans increased confidence in the banks.
Governments resort to counterproductive half-measures because facing problems is political suicide. The main cause of Japan’s endless recession is, in my view, the Plaza Accords. The value of the yen doubled in a few months, which turned Japan into an insanely expensive country. An economically appropriate response might have been to take advantage of the cheaper currencies offered by all other countries and boosted immigration and imports to allow companies and individuals to take advantage of suddenly cheaper labor and. Japanese companies could have concentrated on the high value added areas where they have a competitive advantage—like building cars—while letting factories in—and immigrants from–poorer countries handle the low value added functions.
However, proposing to let suddenly uncompetitive Japanese companies sink or swim and allowing unwashed foreign hordes to invade xenophobic Japan would have been political suicide. Instead BOJ eased monetary policy, creating a property bubble, much like America’s Fed did after the Internet bubble. Meanwhile, Japanese deflation began with the importing of massively cheaper foreign goods—like golf equipment and beer—and has continued for two decades. Deflation appears likely to continue for the foreseeable future. Mercer Consulting still ranks Tokyo as the most expensive city in the world, followed by Osaka at #3 and Nagoya at #10. (For reference, London is #25 and New York #33). Indeed, like an opening act which threatens to cut into the time allocated to the headline performer, deflation and stagnation have intruded upon Japan’s next crisis: the explosion of its demographic time bomb.
The reason that Japan—and now many other governments—turned to Quantitative Easing is not that it is effective, but rather that it creates the illusion that the government is attacking the problem without in fact incurring any of the distress that would be associated with an effective response to past excesses. Indeed, it is hard to identify any parties who particularly suffer from quantitative easing in the short-term (the only term understood by most politicians). This distraction may help Abe remain in office for longer than the “one night stands” enjoyed by most of his predecessors (Japan has had 21 Prime Ministers since the Heisei era began 24 years ago, including Abe himself for a year in 2006-07), it won’t solve Japan’s problems.