This article was written by Richard Horswill. All views and opinions expressed are strictly his own.
One might be excused for not necessarily understanding the title of this article: however to a particular vintage of reader, the Vapors were a band from the late 70s/ early 80s famous for the catchy tune “Turning Japanese.” This title could be more relevant than one imagines in today’s financial circumstances of the UK and others. But first, what does turning Japanese look like?
As of 2022, the Japanese public debt is estimated to be approximately US$12.20 trillion US Dollars or 266% of GDP, and is the highest of any developed nation. Japan’s asset price bubble collapsed in 1991, leading to a prolonged period of economic stagnation, with GDP falling significantly in real terms through the 1990’s. In response, the Bank of Japan set out in the early 2000s to encourage economic growth through a non-traditional policy of quantitative easing. By 2013, Japanese public debt exceeded one quadrillion yen (US$10.46 trillion at the prevailing exchange rate), which was about twice the country’s annual gross domestic product at that time, and already the largest debt ratio of any nation. This pattern of monetary behaviour has in essence been adopted as a new orthodoxy, thus the Japanese debt phenomenon and control mechanism has been in part replicated by indebted nations worldwide. It is currently the reversal of this mechanism driven by so called “inflation” that is worrying, and it is clearly not just a UK issue. We are currently in a perceived currency crisis and a potential sovereign debt trap – along with all other debt laden nations particularly as the perceived wisdom is to tackle the inflation story with the one and only tool in the central bankers tool box! Interest rates!!
The twin supply shocks of COVID and war have led to consumer price inflation (CPI) at levels not seen since the 1970’s. The unfortunate side of the crisis that the monetary authorities have created is the narrative that to tackle “the inflation” they need to raise interest rates. This would certainly be true if it was a demand side “money” led inflation, where too much money was chasing too few goods. However, supply chain breakdowns combined with high energy costs driven by tit for tat sanctions in a war zone, and also alongside a lack of investment in the fossil fuel sector over several years – pressured by the green agenda – has created the perfect storm to drive CPI. Energy drives the world and the cost of all goods, particularly food. This has clearly taken hold of the senses of Central Bankers who will do whatever it takes to quell CPI, primarily driven by the need to be seen to be doing something. The reality is that in the macro world, transitory can still be quite a long time. However, the call to arms from transitory to outright central bank panic has not been long in a macro context. Interest rates have a time lag, whereby markets digest and correct valuations. But when rates double, treble and quadruple in short order, tensions will occur. The big question is at what point does the global financial system collapse under the weight of debt servicing? And when that occurs, and it surely will, what will the monetary authorities be forced to do? The Pivot! This will be the point at which we will be turning Japanese and the credibility of central bankers will be shot as they attempt to halt the self inflicted global financial turmoil. A full reversal of policy will look like 2008 and 2020 again, whereby interest rates are cut sharply, quantitative easing is re-employed to suppress rates and the likely next step on the agenda will be to follow the Japanese mantra of yield curve control where the Central banks backstop the entire bond market right across the curve.
The UK Government has taken it upon itself to drive the growth agenda. This clearly is a necessary requirement in a debt based financial system as without new money being borrowed into existence (inflation, the monetary phenomenon) debt deflation will ultimately bring about a collapse in the system as seen in the 1929 Great Depression. However, government can only stimulate so much without confidence being lost in its policies, particularly if it is seemingly unfunded, which means that it also requires central bank assistance. This will require the central bank to allow interest rates to do what they need to do, which is to drop to levels that will provide stimulus for private enterprise to take risks, drive innovation and also occasionally fail. Inverted yield curves are crying out for an end to interest rate hikes and softening oil prices are now indicating signs of demand destruction signalling enough is enough in rate hike terms. Overly indebted western economies are destined to follow the path of least resistance which will ultimately be the Japanese route.
The UK is also looking like the possible first significant mover into a global currency crisis and debt crisis as the US dollar wreaks havoc on the global debt markets for economies. Of course, the main driver of the strength is deemed to be interest rate differentials as the Federal Reserve continue to indicate CPI busting interest rate rises and cram big hikes in at every opportunity to signal to the market that they are in charge. This is only part of the story as liquidity is being drained from the global economy as the offshore eurodollar system is curtailing new dollar liquidity as banks fear to lend into a global recession, meaning that dollar shortages are ultimately driving the dollar to multi decade highs. This puts massive stress on the over leveraged sovereign governments sitting on dollar denominated debt, such as China and Turkey, but there are as many as 30 countries looking for assistance from the IMF to help stem the haemorrhaging that their dollar debts are creating.
Turning Japanese looks likely to be the only possible solution to maintain global financial stability after the “in denial” but somewhat anticipated financial, currency and sovereign debt crises, whilst solutions are sought to overcome the global debt overhang. Negative real interest rates are the historical precedent to follow; however, the twenty plus years of Japanese interest rate control and manipulation is likely to be an unpopular mechanism due to its ability to create inequality as the wealthy always get the cheap money first. Low global growth and deficit spending governments also look the likely order of things to come, with CPI being tamed naturally as restrictive bank lending globally will overall be maintained due to mistrust of the interbank system and fears of collateral value and bank failure. This will give more credence to the Japanese sustainment model, and the vapours of Japanese monetary policy will continue ooze into financial markets.
