Opinion

Anatole Kaletsky

After initial promise, Japan’s new economy risks backsliding

Anatole Kaletsky
Nov 29, 2013 15:55 UTC

At a time when economic optimism is growing and stock markets are hitting new highs almost daily, it is worth asking what could go wrong for the global economy in the year or two ahead. The standard response, now that a war with Iran or a euro breakup is off the agenda, is that some kind of new financial bubble could be about to burst in the U.S. But a very different, and rather more plausible, threat is looming on the other side of the world.

Japan is the world’s third-biggest economy, with national output roughly equal to France, Italy, Spain, Portugal and Greece combined. This year, Japan has become, very unusually, a leader in terms of financial prosperity and economic growth. According to the latest IMF forecasts, Japan’s 2 percent growth rate in 2013 will be the fastest among the G7 countries, easily outpacing the next strongest economies, Canada and the U.S., each with 1.6 percent growth. Japan’s stock market has gained 70 percent since last December, far exceeding the 25 percent bull market on Wall Street, and Japan’s corporate profits are projected to increase by 17 percent, according to Consensus Economics, compared with the paltry gains of 3 to 4 percent in Germany and the U.S.

As someone very much caught up in the economic optimism inspired by the election of Shinzo Abe, I fear it is now time for a reality check. And observing the complacent inertia that seems suddenly to have paralysed Japan after July’s Upper House election, it seems worth recalling the famous maxim (usually attributed to Keynes) about unexpected events: “When the facts change, I change my mind.”

The reasons for pessimism follow directly from the main driving forces of Japan’s new economic programme, the so-called “three arrows” of Abenomics: fiscal stimulus, monetary expansion and structural reform. The second of these arrows — monetary expansion — is flying as fast as ever. But the first, fiscal, arrow is about to turn into a boomerang that could kill Japan’s economic recovery stone dead. In April an increase in consumption tax from 5 to 8 percent, along with some cutbacks in public spending, will produce a narrowing of the structural budget deficit worth 2.5 percent of GDP, according to the IMF.

This massive fiscal tightening, which happens to be exactly equivalent to the U.S. fiscal tightening in 2013, to Italy’s in 2012 and to Britain’s in 2011, is a very big risk to take with the Japanese economy’s still-tentative recovery. While the Abe government has made vague promises to cut other taxes or boost public works spending to offset some of the deflationary impact of the consumption tax increase, it has notably failed to provide any details. Given that the tax hike will hit the economy in April, time is running out for any effective offset to be proposed. It seems, in fact, that the Finance Ministry opposes any significant easing of next year’s fiscal burden. Far from being ready “to do whatever it takes” to promote economic recovery, as I had expected, Japan’s bureaucracy seems to prefer to wait and see how April’s tax hike affects the economy before proposing any compensating relief. The trouble is that by the time a collapse in consumption becomes apparent, it may well will be too late to prevent another recession.

The end of the Fed’s taper tantrum

Anatole Kaletsky
Nov 21, 2013 15:03 UTC

Following Wednesday’s publication of the Federal Open Market Committee minutes, we now know that a reduction in U.S. monetary stimulus could be on the agenda for the next FOMC meeting on December 19. How much does this matter?

When the Fed unexpectedly decided not to “taper” in September, the markets were stunned and gyrated wildly, although investors had only themselves to blame for being wrong-footed in this way. Ben Bernanke had made crystal clear his reluctance to reduce monetary stimulus as long as the U.S. economy appeared to be weakening, which appeared to be the case throughout the summer. By December 19, the situation may well be very different, since the economy will probably be improving and the U.S. fiscal stalemate may well have been resolved. If such improvements happen, the Fed will have no compunctions about wrong-footing investors again, in the opposite direction, as this column suggested last month.

So what will be the impact on the world economy and financial markets if the Fed decided to taper as early as December? The answer is, not much. As long as the Fed stands by its commitment to keep interest rates near zero for the foreseeable future, tapering will have no major economic impact. Therefore its financial significance should also be marginal, except insofar as investor psychology overwhelms rational economic analysis.

Central bank stimulus is here to stay, but what if it fails?

Anatole Kaletsky
Nov 14, 2013 16:29 UTC

If anyone still doubted that central bankers all over the world will keep interest rates at rock-bottom levels, those doubts should have been dispelled this week. Janet Yellen’s statement on Thursday to the U.S. Senate that the Fed has “more work to do” to stimulate employment, and that “supporting the recovery today is the surest path to returning to a more normal approach to monetary policy,” capped a series of surprisingly clear commitments to easy money from central bankers this week. On Wednesday Joerg Asmussen, a member of the executive board of the European Central Bank, and Ewald Nowotny, the Austrian central bank governor — both of whom had previously been reported as voting against last week’s surprise ECB rate cut — said that they might in fact support further rate cuts and even negative interest rates, as well as the possibility of breaking the taboo against U.S.-style purchases of government bonds. And Mark Carney, the Governor of the Bank of England, reiterated more strongly than ever that any early increase in British interest rates was out of the question, despite the fact that the outlook for the British economy has turned out to be much better than the BoE had expected.

But what if these zero interest rate policies produce disappointing results in the year ahead, as they have in each of the past four years? What if the world economy fails to spring back to life or just plods along with sub-par growth, despite all this stimulus, as has happened in each of the past four years?

With luck, these questions will not need answering because fiscal austerity has acted as a powerful headwind to economic recovery in the U.S., Europe and Britain and these budget consolidation efforts are now being relaxed. The new records on Wall Street and other stock markets suggest growing confidence among investors that monetary stimulus will finally deliver decent levels of growth next year — and this does indeed seem likely. But what if the optimism turns out to be wrong? What if the U.S. and Britain fail to grow by at least 3 percent next year, and what if Europe stays stuck with sub-1 percent growth and mass unemployment? In that case, the monetary and fiscal policy experiments since the Lehman crisis would have to be judged as failures — and that judgment would open the way to much more radical ideas than zero interest rates and QE. Such radical ideas would be of two opposing types.

This weekend, China will plot its economic future

Anatole Kaletsky
Nov 6, 2013 20:13 UTC

The ponderously named Third Plenary Session of the 18th Central Committee of the Chinese Communist Party, which takes place this weekend, is a more important event for the world economy and for global geopolitics than the budget battles, central bank meetings and elections that attract infinitely more attention in the media and financial markets.

The obvious reason for this meeting’s importance is that China is destined in the long run to become the world’s biggest economy and a political superpower. And the Third Plenum, traditionally held roughly 12 months after the appointment of a new Party leadership, has been used twice before as an occasion for the new leaders to spell out the main strategies they hoped to implement as they consolidated their power. At the Third Plenum in 1978, Deng Xiaoping launched the market reforms that unleashed the power of the profit motive in China, and it was at the corresponding event in 1993 that Jiang Zemin accelerated the process of dismantling state-owned enterprises and integrating China into the world economy that culminated with China’s accession to the World Trade Organization in 2001.

A second, more immediate, reason for the world to pay attention to this weekend’s meeting is that China has recently become not just the strongest engine of growth in the world economy, but also the biggest source of potential economic surprises, both good and bad.

Don’t expect the euro’s rally to last

Anatole Kaletsky
Oct 31, 2013 15:05 UTC

What is happening to the euro? Currencies are more important than stock market prices or bond yields for many businesses and investors, not to mention for globe-trotting families and humble tourists. Which makes it surprising that so little attention has recently been devoted to the strengthening of the euro, which hit its highest level since 2011 this Monday, having jumped by 5.5 percent since September and over 8 percent since early July. This remarkable ascent, which has also driven the euro to its highest level against the yen since the 2008-09 financial crisis, means that European exporters are losing competitiveness, Americans and Asians who live or travel in Europe are feeling like poor relations and many economists are starting to worry that Europe’s nascent economic recovery will be snuffed out.

Purely financial players, by contrast, seem to be more enthusiastic about the euro’s strength than they have been for years. Speculative futures bets in favor of further euro appreciation have reached their highest level since the summer of 2011 — and the only time they were higher than that in the past decade was in the period just before the Lehman shock. Significantly, both of these speculative crescendos were followed by sharp euro declines, since currency markets generally turn when bullish sentiment reaches extreme levels. But there is a deeper reason to expect the euro’s seemingly irresistible rise to reverse.

Currencies tend to move in trends for many years, and the fact is that the euro’s long-term trend against the dollar is still almost certainly downwards, despite the big gains of the past few months.

With hostage taking over, a Washington deal beckons

Anatole Kaletsky
Oct 24, 2013 15:37 UTC

Nobody should be surprised that Wall Street hit new records this week. After all, the U.S. has just witnessed the end of a sensational hostage crisis that was threatening national security and undermining economic confidence — and even more sensationally, this was the second such crisis in two months.

John Boehner was held hostage by Republican hardliners until last Thursday, when the U.S. Congress voted to continue pumping money into the U.S. government. The fiscal militants forced Boehner to endanger the U.S. economy with threats of a Treasury default. Boehner reluctantly paid this rhetorical ransom in order to preserve the appearance of party unity and therefore his own credibility as a political leader.

Now consider events a month earlier on the other side of Washington. Until September 18, when the Federal Reserve voted to continue pumping money into the U.S. bond market, Ben Bernanke was arguably held hostage by the Fed’s hardliners. The monetary militants forced Bernanke to endanger the U.S. economic recovery with threats of a premature end to quantitative easing. Bernanke reluctantly paid this rhetorical ransom in order to preserve the appearance of institutional unity and therefore his own credibility as an economic leader.

The positive side of the budget debacle

Anatole Kaletsky
Oct 17, 2013 15:07 UTC

The U.S. budget battle was always likely to end in a Republican defeat and a rout for Tea Party firebrands; but the outcome has turned out to be even more dramatic: an unconditional surrender, instead of the negotiated ceasefire suggested here two weeks ago. Trying to spot historic turning points in real time is always risky, but the scale of this debacle suggests that U.S. politics and economic policy really will be transformed in at least four important ways.

Firstly, the shift in the balance of power between Obama and the Republicans since last November, described here, has been spectacularly confirmed. It is too early to guess whether the GOP’s slumping popularity will give the Democrats a chance to regain control of the House of Representatives next November. The Democrats would be very likely to achieve this if they could hold on to their present lead of 5.5 percentage points in the Real Clear Politics average of Congressional vote polling, since this would represent a swing in favor of the Democrats of 4 percent, which should suffice to win the extra 17 seats they would need to win control.

Conventional wisdom in Washington contends that a Democratic win next year is almost impossible because of a historic tendency of presidential parties to lose votes in midterm elections, but this history has little statistical significance, and is counterbalanced by the voting figures from the three occasions since 1945 when parties that lost the popular vote kept control of the House. In all these cases the majority party in the House only lost the popular vote by tiny margins — in 1952, by 0.5 percent, in 1996 by 0.7 percent and in 2012 by 1.2 percent. So an election in which the Republicans lost the popular vote by 5.5 percent, as indicated by recent polling, but kept control would create a totally unprecedented situation. In any case, speculation about next year’s election is pointless since the polls are likely to shift abruptly — one way or the other and for reasons we cannot even imagine today. What is clear, however, is that the Republicans face deep unpopularity in the short-term and this will transform the outlook for economic policy in the next few months.

Learning budget lessons from Japan and Britain

Anatole Kaletsky
Oct 10, 2013 14:55 UTC

While the world is transfixed by the U.S. budget paralysis, fiscal policies have been moving in several other countries, most notably in Japan and Britain, with lessons for Washington and for other governments all over the world.

Let’s start with the bad news: Shinzo Abe’s decision to increase consumption taxes from 5 to 8 percent next April. This massive tax hike, to be followed by another increase in 2015, threatens to strangle Japan’s consumer-led growth from next year onwards, since Abe looks unlikely to offset this massive fiscal tightening with stimulative measures that would maintain consumers’ spending power. Even if Abe delivers on his vague promise to compensate with business tax reductions, these will only aggravate the over-investment and corporate cash hoarding that have long distorted the Japanese economy. Meanwhile, the government’s willingness to risk economic recovery in the cause of fiscal discipline implies that those of us who believed Abe was making an unconditional commitment to do whatever it takes to achieve economic recovery were simply wrong. Now that the forces of budgetary austerity have reasserted themselves, Japan’s probability of ending its decades of stagnation is much reduced.

Now for the good news: a change of attitude to debt and borrowing is transforming Britain from the second-weakest G7 economy (after Italy) into a world champion of growth. As recently as last April, the British government was attacked by the International Monetary Fund’s chief economist for “playing with fire” by trying too hard to reduce its budget deficits. This week the IMF World Economic Outlook praised Britain’s rapidly improving economy and upgraded 2013 growth projections by 0.5 percentage points, to 1.4 percent. That may not sound like much, but this improvement comes when almost every economy is being downgraded — and compared with last year’s miserable 0.2 percent growth rate, it feels almost like a boom.

Game theory and America’s budget battle

Anatole Kaletsky
Oct 3, 2013 14:17 UTC

So far, the battle of the budget in Washington is playing out roughly as expected. While a government shutdown has theoretically been ordered, nothing much has really happened, all the functions of government deemed essential have continued and financial markets have simply yawned. The only real difference between the tragicomedy now unfolding on Capitol Hill and the scenario outlined here last week has been in timing. I had suggested that the House Republicans would give way almost immediately on the budget, if only to keep some of their powder dry for a second, though equally hopeless, battle over the Treasury debt limit. Instead, it now looks like President Obama may succeed in rolling the two issues into one and forcing the Republicans to capitulate on both simultaneously.

The ultimate outcome of these battles is now clearer than ever. As explained here last week, the Tea Party’s campaign either to defund Obamacare or to sabotage the U.S. economy was doomed by the transformation in political dynamics that resulted from November’s election — above all by the fact that the president never again has to face the voters, while nearly every member of Congress must. This shift in the balance of power made the Republicans’ decision to mount a last stand on Obamacare, instead of attacking the White House on genuine budgetary issues, politically suicidal as well as quixotic. But while the outcome now looks inevitable, the timing of the decisive battle is important. Financial markets and businesses have responded with a tolerance bordering on complacency to the shenanigans in Washington, but this attitude could change abruptly if the House Republicans’ capitulation is delayed too long. As they say in the theater, the only difference between comedy and tragedy is timing.

The risk, as everyone now realizes, is that the battle of the budget — which turns out really to be just a minor tussle over the funding of a limited range of worthy but nonessential government services — remains in a stalemate right up to October 17, when U.S. Treasury is expected to hit its debt limit. At that point, an immediate settlement will be needed or all hell could break loose. The key question for businesses and investors around the world, therefore, is whether the Republicans’ impossible demands to defund Obamacare are removed from the budgetary bills comfortably before the October 17 deadline, or whether this capitulation is triggered by a financial crisis once the deadline draws too close.

Why markets don’t fear a government shutdown

Anatole Kaletsky
Sep 26, 2013 14:44 UTC

Now that the worldwide panic over U.S. monetary policy has subsided, Washington is brewing another storm in a teacup: the budget and Obamacare battle that reaches a climax next Monday, followed by the debt limit vote required to prevent a mid-October Treasury default. The ultimate outcome of these crises is a foregone conclusion. As Senator John McCain told the press this week: “We will end up not shutting down the government and not de-funding Obamacare.” He could surely have added that a Treasury default is also out of the question.

But how exactly will Washington manage to dodge these bullets? As McCain added, “I don’t know what all the scenes are, [although] I’ve seen how this movie ends.” Markets understandably fear that all the plot twists leading up to a seemingly satisfactory resolution could produce an economic horror film, crushing business and consumer confidence, damaging economic growth and triggering a major sell-off in global stock markets. That, after all, is exactly what happened when the U.S. Treasury almost defaulted in July 2011.

What, then, are the chances of similar disruption in the weeks ahead? The risks this time are much smaller than in 2011 because of four events that have transformed the dynamics of U.S. budget battles.

  •