Right now, Japan’s equity markets are being buoyed by the same “Print-And-Spend” policy that the Federal Reserve used to pay off Wall Street, emanating from the same ivory tower that paid untold trillions in bonuses to America’s failed bankers. Meanwhile, a motley crew of high-level economists including Ben Bernanke’s Princeton colleague Paul Krugman continue to exhort the Japanese to “Print! Print! Print!” their way to prosperity. As if printing more dollars and yens was some restorative, magical monetary panacea to cure a nation’s economic ills.
One of Krugman’s areas of expertise is, of course, the “liquidity trap.” This is when bond yields sink so low, the market treats them like cash. He has written that Japan’s “lost decade,” the 10 (or 20, depending on who you ask) years following the collapse of Japan’s real estate bubble, was an extended liquidity trap. Like cockroaches dosed for generations with insecticides, in a liquidity trap the markets become immune to further cash injections. In Keynesian economics, the central bank’s job is to manage interest rates by adding or withdrawing liquidity — buying or selling bonds in the open market. Thus, in the liquidity trap government policy is incapable of stimulating economic growth.
Krugman has argued that Japan’s government hasn’t thrown enough cash into the system. With the Abe government firmly in place after last month’s elections, Krugman and his Keynesian buds have a ringside seat at a real live social experiment: Will Abe-nomics, with its tsunami of banknotes, bail out Japan, or will the economy continue to lag?
Mind you, not everyone thinks Japan is lagging. Some observers point out that most Japanese kept their jobs during the “lost decades,” and that measured by standard of living, foreign trade, and the strength of the currency, Japan’s decades weren’t “lost” at all. This must also be seen through the lens of cultural values and expectations: The Japanese value stability of employment more than the ability to climb the corporate ladder.
Anyway, for the time being Shinzo Abe, the well-liked — and re-elected — Prime Minister, is printing Yen for all he’s worth, and Japan’s stock market is inflating like a giant balloon at the Macy’s Thanksgiving Day Parade. Abe’s winning the election could provide the political stability for much-needed economic reforms, but for now he’s mirroring America’s experiment in putting free money in bankers’ pockets. This policy should work well for their equity markets — until it doesn’t.
But don’t look anywhere else in Asia for comfort. The rest of Asia’s policymakers are well and truly out of ammo as Asian economic growth has been nearly cut in half since 2010.
And if you weren’t worried about China, now would be a good time to start.
China has been the main driver of growth in the region, accounting for nearly 38% of all Asian GDP last year. Now the Chinese government is acknowledging that growth is in a downturn, publicly forecasting growth in the 7% range — well below the double digits of only three years ago.
China’s fixed capital formation grew like Topsy during the expansion years. But many of these were empty make-work projects designed only to inflate GDP, leaving the country awash in unused airports, unfinished roads and office buildings — and in bank loans for these projects with no revenues.
China’s banks are a loudly ticking time bomb. Their assets are bloated to an estimated 270% of GDP. A huge percentage of those “assets” are already in creditor limbo, having secured roads and bridges and tunnels and airports to Nowhere. China’s banks face a potential crisis as investment in major fixed asset projects declines amid eroding liquidity throughout the financial system.
Rising rates should hit China’s markets too, pushing Asian rates higher. This will clobber the region’s capital-intensive economies, many of which expanded capacity specifically to serve Chinese demand. Rising rates — globally, but especially in the “safe haven” U.S. Treasury market — coupled with a strong Dollar, should punish overvalued Asian currencies, sparking inflation, but in the context of economic decline. This spells economic trouble and the potential for social unrest.
Hedgeye Senior analyst and keen-eyed Asia watcher Darius Dale says Chinese policy makers are starting to appear less concerned about a possible domestic asset price bubble. This could give them more flexibility in some kind of easy-money policy aimed at domestic stimulus. Any such policy move is likely to be slow to be implemented and much slower to take effect.
Dale cautions that massive debt rollovers generally slow economic growth by sucking liquidity out of the financial system, “diverting incremental credit from productive enterprises.” Perhaps more crucial is the impact on a fragile economy, which can hamper the creation of a stable economic base by diverting liquidity away from marginally productive business, or from temporarily unproductive ones that are merely trying to weather the economic storm.
Finally, any debt rollover China’s leaders may contemplate will almost surely not be offset by a significant increase in private savings. Without China to fuel the engine, Asia’s economic racecar looks to be in for a long pit stop.
Moshe Silver is a Managing Director at Hedgeye Risk Management and author of Fixing a Broken Wall Street.