Japan has reached ‘V1’

JAL 1

In aviation, the term ‘V1’ is applied to the point during a take-off when the aircraft has reached a speed that is beyond the point of no return.

In other words, upon reaching V1, the aircraft will be travelling so fast and approaching the end of the runway at such as speed that it will no longer safely be able to abort the take-off. It is committed to attempt a take-off, even in the case of engine failure or some other malfunction. This is a rather accurate, if somewhat dramatic, analogy to the state of the Japanese economy at the moment.

Abenomics combined with truly massive QE is attempting to force the economy back on a growth track after two decades of deflation and sub-par growth. Some growth has already emerged, as evidenced by the latest set of GDP figures. Consumption seems to be responding to the spectre of inflation, but business investment is still in the doldrums. However a not insignificant proportion of GDP growth over the most recent few quarters was driven by government spending, which at best is a short-term artificial stimulus with no lasting effect on the economy, and at worst the cause of economic distortions, f.ex. in the construction sector which has had countless buckets of government money throw at it over the years.

Here at NipponMarketBlog, we’re not too surprised that GDP growth has started to pick up, or indeed that inflation seems to be rising slightly. In fact, if that had not been the case after such a concerted effort by both the government and the BoJ, we could probably already have declared Abenomics a failure.

However, the rise in inflation is almost certainly a ‘cost push’ effect as opposed to the much more desirable ‘demand pull’ effect, as we discussed here: https://nipponmarketblog.wordpress.com/2013/04/19/the-hamburger-inflation-fallacy-cost-push-vs-demand-pull/

mcdonalds_japan

Similarly, the growth in GDP may prove somewhat more fleeting than the authorities are hoping. The problem with recent GDP growth and inflation figures is two-fold:

1. Any government can easily produce economic growth as measured by GDP if it really wants to. There is no magic involved. Simply speaking, all it has to do is borrow the money in the bond market (for as long as that is still possible) and then spend it on some government project. This automatically results in an increase in GDP, even if the bridge being built or the road being laid adds no economic value subsequently. It is purely an accounting effect.

2. If growth does not become both sustained and self-sustained over the next several months (and even years), it is very likely that the initial spurt may peter out as consumers and businesses realise that in fact nothing has really changed because the structure of the domestic economy remains unchanged. This could possibly happen in conjunction with a slowing global economy, which is what we seem to be facing at this point in time. In addition, if the ‘cost push’ inflation that the country is experiencing right now is not followed by wage increases, then the consumer is likely to cut back significantly on expenditure, even if inflation continues to rise.

Within the context of fiscal stimulus to the economy, it would from a free market perspective make a lot more sense to cut taxes rather than to increase spending. The impact on the budget deficit would be negative in both cases, but at least a tax cut would have some hope of letting the private sector allocate resources and create demand sustainably in sectors of the economy where what might be called ‘latent growth’ is currently residing. However, and quite bafflingly, the government is already considering raising the consumption tax from 5% now to 8% in April 2014, and then to 10% in October 2015. As recently as May 16th, Economy Minister Amari said the GDP data showed that the economy appears to be developing favorable conditions for a consumption tax hike, although a final decision will be made after second quarter data, due in August.

This short-term desire to reduce the deficit by hiking taxes could turn out to be a costly mistake. With comments from government officials like these in mind, it is perhaps not surprising that consumption seems to have picked up recently, especially in areas such a cars.

Carsbeingshipped

If the consumers think that a consumption tax hike is coming, they would rationally move their planned expenditure forward to avoid paying a higher tax later in the year. This makes the consumption growth in Q1 GDP figures look somewhat more tenuous than they perhaps did at first glance. Add to this the fact that one of the factors most highly correlated with consumer confidence is the level and direction of the stock market, and with the Nikkei 225 up more than 50% in 8 months, it is perhaps no wonder that consumers feel more confident lately. It is worth keeping in mind that this is of course a double-edged sword. If the Nikkei 225 continues its recent correction, consumer confidence could easily be dented.

Consider also the added complications of possible ‘time inconsistency’ problems that could potentially arise. If ‘cost-push’ inflation starts to rise, thus pushing up interest rates, then the resultant increased debt service burden facing the government will materialise well ahead of any subsequent rise in tax revenues. We have discussed this issue in more detail here: https://nipponmarketblog.wordpress.com/2013/05/29/interest-rate-rises-and-time-inconsistency-problems/

Analysis2

At any rate, when viewed in this way, it is apparent that if the two effects regarding GDP growth and consumer behavior presented above become reality, then the only option available to the government is paradoxically to attempt to do more of the same.

The reason for this is that if growth (and perhaps also the budding inflation) is faltering, reducing government expenditure or raising taxes or indeed dialing back the BoJ’s QE will only make things worse. The government and the BoJ  will have to do the exact opposite. They will have to increase spending even more, which means borrowing even more in the JGB market and thus pushing the debt-to-GDP ratio even higher and thereby pushing the country closer to an eventual debt default. In addition, the BoJ will have to accelerate QE in order to drive the Yen even lower and consequently the inflation rate even higher, regardless of whether wage inflation can keep up.

Having thus fired up the engines, the only thing they can do from then on is to push even harder in an attempt to ensure take-off. Abe-san in the pilot’s seat, wrestling with the fiscal stimulus controls. Kuroda-san in the co-pilot’s seat, pushing the QE throttle as far forward as it will go. Both of them desperately hoping the aircraft will lift from the runway, without anything breaking.

They are now committed.

They are at V1.

A Japan Airlines aircraft takes off at Haneda airport in Tokyo

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11 responses to “Japan has reached ‘V1’”

  1. Ron Campbell says :

    Great analogy… but even more frightening if you happen to be a passenger on the plane. And you suddenly realize the pilot and co-pilot both flunked out of flight school.

  2. Andre says :

    In an ideal world, the japanese government would dramatically reduce expenditures and start lowering the debt levels at the fastest rate possible. Structural tax and legal changes aside (though radical changes could have radical results), the best thing that could be done for the japanese economy is a radical austerity program. It may not result in higher GDP but it would result in a higher, and healthier, GNI. There are advantages to being a nation of retirees; but that requires productive investments to fund said retirements. It makes no difference where in the world these investments are located. Unless there is a quantum leap in robotics or they open up to immigrants, the elderly in Japan can’t rely on tax revenues for income.

    To say they have no other options or that to reverse course would make things worse is nonsense. There is actually only one good thing about current policies: the possibility of government debt being inflated down, which improves the structural picture for Japan’s productive sector. There is not going to be a takeoff, period. Any and all improvements in the economy will be followed by a larger crash soon after. There is absolutely zero chance of these policies working and I don’t think anyone would be stupid enough to try them thinking they would. I think they are deliberately setting things up for a currency devaluation, not to benefit exporters or any of that nonsense, but for the plain and simple purpose of lowering the real debt levels in a politically acceptable manner.

    The talk about improving business conditions is great and would help. It always does. But it doesn’t require QE and it will take more than promoting japanese food abroad and letting people buy drugs online to make any real impact.

    • NipponMarketBlog says :

      All of your points are valid, but talking about what Japan could do “in an ideal world” is rather pointless.
      This is not an ideal world, and the chances of sweeping reform and austerity being implemented are even smaller than the chances of Abenomics working (and the chances of Abenomics working are tiny).
      In the REAL world (as opposed to the ideal world), they can’t back down from their efforts to ignite growth because the economy would simply collapse in a heartbeat (along with the JGB market and the stock market), and in the REAL world the is no chance whatsoever that the political class – in what is effectively the world’s largest socialist country – can suddenly find the back-bone to produce long term fiscal reform, and exhibit responsibility of the magnitude required to credibly reduce the debt. With their best efforts, they can’t even reduce the deficit, never mind the debt.
      You are correct though in saying that underneath it all, the actual policy of the government and the BoJ is to weaken the Yen and monetize the debt through inflation.

      • Andre says :

        Well they can try to ignite growth all they want, it’s not going to happen no matter what kind of Voodoo Spell they cast. Will Abenomics succeed in disarming the JGB bubble before it blows up? I have no idea.

      • NipponMarketBlog says :

        I very much doubt Abenomics is enough. In fact, I am almost certain that it isn’t. True structural reform can only be successful if it comes from the bottom up, i.e. the corporate sector. No legislation or encouragement from government is going to change anything in any meaningful way.

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