At last, Japan may be about to abandon its disastrous Keynesian consensus

Moving towards a balanced budget 20 years late

By Thomas Pascoe

The world’s third largest economy is in crisis. That, in itself is not news. The world’s largest economy is also in crisis, as is its second, as is…

What is newsworthy is that, having tried and failed with every other option, the Japanese government may be taking a remarkably novel approach. It appears as though they are going to try to spend close to what they receive in taxation. The Keynesian consensus is coming to an end in Japan, although not before it has wrought enormous damage to one of the world’s great economies.

“The government running out of money is not a story made up. It's a real threat," said Japan’s finance minister Jun Azumi on Friday. Opposition parties in Japan are blocking a deficit financing bill which would allow the government to continue to drive its debt levels above 200pc of GDP. If the opposition holds firm, the government has threatened the unthinkable – it will spend less. Tax rises are also on the table, although the doubling of sales tax to 10pc will not come fully into force until 2015.

This is a turnaround for Japan. The nation’s government has already contorted itself in all the ways now common in the West while attempting to postpone this day. This, after all, is a country whose own central bank rebuked itself last month for breaking its own rule and buying more bonds than there is currency in issue.

As in the West, the Japanese have stuck to the dogma of easy monetary policy to fight decline, and as in the West it has not worked. The Japanese instituted Quantitative Easing a decade ago and found that it has done little to fight deflation and nothing to avert stagnation.

Interest rates close to zero did work for a while, but not in the manner imagined. Now that Japan is not unique in having a low interest rate, the correction has been harsh.

The end of the yen carry-trade, where investors would borrow in yen at very low rates and shift their money into high risk investments in foreign currencies, has been devastating. When Japan was alone in having an artificially low interest rate, it attracted speculators. These speculators forced down the price of the yen by effectively taking a short position in it against an asset. This helped Japanese exporters because the currency was far weaker than fair value.

Now that the whole world has artificially low interest rates, the trade has unwound. The yen has appreciated 45pc in the last five years and is now within 5pc of its post-1945 high.

The manufacturing industry has been hit hard as US and German manufacturers have picked up market share. Factory jobs are at their lowest ebb since records began in 1953, while Japanese manufacturers will make 39pc of their products abroad this year, another record. Bloomberg has reported that one Japanese study envisages four million jobs being lost as Japanese manufacturers relocate production in the next decade. The impact of the currency on this cannot be overstated – Goldman Sachs has estimated that, for every one yen appreciation against the dollar, Toyota loses 3.3pc of its revenues.

Even so, Japan is in a better position than similar Western economies. For a start it has (or had at year end 2011) the best net asset position in the world, where assets held abroad are concerned. Net assets owned abroad by the Japanese central bank and private investors amounted to 54pc of GDP at the start of the year. In contrast, Britain had a net global liability of 13pc of GDP. The Japanese have liquid assets abroad which they can monetise and repatriate to mitigate any meaningful austerity programme, something our government lacks.

Moreover, despite China’s ‘hard landing’ and a shared cultural antipathy between the countries, Japan’s proximity to China should allow it to maintain a lucrative foothold in the largest of all the BRIC's, thus ensuring that the high end manufacturing industry does have a future as a meaningful component of the economy. Again this places Japan in a better position than Britain with its dependence on financial services.

However, Japan’s horizons have been blighted by cloud for much of the past two decades. If anything, those clouds are now blackening. The long-term impact of the Fukushima explosion, in terms of public health, is anyone’s guess. The clean-up work undertaken in and around the plant since the explosion has been exceptional. However, there is every chance that the generation coming to maturity in the next two decades may be blighted by significant levels of incapacity, hampering the economy and requiring even greater state spending.

The Japanese may have arrived at the idea of moving towards a balanced budget both 20 years late and by accident, but it offers them a chance to consolidate and restore order to the public finances. At a time when public appetite for government debt has fallen to a seven-year low, reducing borrowing is not just the sensible option, it's the only one left.