– and that may not be a good thing
Continental Europe, scarred by currency battles and hyperinflation during the first half of the last century, has established systems to prevent hyperinflation. The biggest is the euro. The euro is a simple concept: at heart, it strips national governments of the right to print paper and call it money.
Thus Greece, for all its economic problems, is being forced to live within its means, electorally doubtless very unpopular. Pre-euro, it’s likely that the government would have simply printed money and inflated away its debt, even at the risk of exposing the country to hyperinflation. It hasn’t been able to do that, so you could argue that the euro has sort of worked for Greece. Pain, but not apocalypse, lies ahead.
Despite Japan’s debt to GDP of 190%, compared with 125% for Greece, it’s fashionable to say that Japan is much the safer bet. In fact, the risk of hyperinflation in Japan exists to a far greater extent than in Greece, since the Bank of Japan (BOJ) is exposed to political pressure, and because of Japan’s more precarious fiscal situation.
Finance Minister Naoto Kan is a personal hero of mine, but he should not be asking the BOJ for measures which could undermine trust in the currency. Japan’s fiscal deficit (i.e., expenditure on normal outgoings plus the cost of servicing government debt) is as bad as Greece’s at 10% of GDP. Only the UK is worse within the OECD group of countries.
The BOJ may have “independence”, but it is also obliged by law to work in line with government policy. It’s that get-out clause which enables Kan and Prime Minister Yukio Hatoyama to keep bludgeoning the BOJ with demands for further monetary easing.
Am I being alarmist talking about hyperinflation? When you look at Japan’s public finances, it’s hard not to wonder. What’s disturbing is the state of Japan’s primary balance. The primary balance is in deficit, which means that government income cannot finance ordinary government outgoings. Unlike the fiscal deficit, the primary deficit is net of government debt. So even without including huge government debt repayments, Japan is in deficit.
Debt spiral
Think of it like an individual not being able to pay for meal and board, let alone service his large credit-card debt. The individual goes further into debt (takes out more credit cards) just to pay off the debt on his first card. The debt income is not being used to increase the individual’s earning prospects, but simply generates more liabilities, which he has to repay by going even further into debt. The only way that downward spiral can be stopped is with bankruptcy.
The link between debt and hyperinflation is confidence. Historically, people immediately spend a currency they don’t trust. A race is launched to spend the money before it depreciates. To compensate for holding bad money, people shove up their prices. A spiral ensues, which can ultimately wipe out the savings of the entire country. Anybody with hard currency makes a fortune, as foreign speculators did in Germany during the hyperinflation period from 1919-1923.
BOJ Governor Masaaki Shirakawa sees the debt monster lurking outside his door, and he’s anxious. He doesn’t want to be the one who oversees a return to hyperinflation. He’s doubtless begging the government to increase the “salary” portion of its income (i.e., tax). That’s why Japanese worries about tax income being lower than debt income are so heartfelt. Once government debt income tips over into being larger than government tax income (as happened for the first time in FY2010 with just ¥37 trillion raised in taxes for a budget of ¥95 trillion), you are facing a world of pain. If debt spirals, the government would then have two choices: honour its debts by printing money, or declare itself bankrupt. No national government in history has ever chosen the second option.
What the Japanese government needs to do is, ironically, become more like Greece: bow to a superior impartial power (in Greece’s case, the euro), slash government expenditure, raise taxes, and remove the threat of hyperinflation. A recession will ensue, but if that is the price of returning to reality, so be it.