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Post details: Samurai of Deficit

Samurai of Deficit

Debt is a preening shadow of wealth and the whole financial world now lurks in it. Not to the same degree though.

If you think that the epicenter of the current fiscal woes lies in the Southern Europe, think again. PIGS (Portugal, Italy, Greece and Spain) may be hogging the spotlight for now, but no country is deeper in hock than Japan. When scrutinizing their public balance sheets you better wear a pair of safety goggles and extra length raincoat. Never having fully recovered from the aftermath of the Nikkei crash in early nineties, and recently hit with the double whammy of the global financial crisis and devastating earthquake, the Land of the Rising Sun amassed public debt in excess of 230% of GDP, which easily dwarfs the figures of even the most profligate budgetary sinners in the Mediterranean - compare that to 160% for Greece or 130% for Italy for instance.

Whether the developed economies can grow out of this predicament without opening too many cans of worms has been the subject of much debate. And truth be told, the jury is still out on this one since in economy anything can happen at any time under any circumstances. Often contrary to the opinions of the best experts in the field. Unlike say physicists, economists can't really make replicable experiments to verify or reject their wild theories. For instance if you want to make an analogy between our situation and post-war world, how do you match all the contradicting factors and relevant macro-economic conditions? You can't. So we just try to seek the truth in debates. And when it comes to deficits, they can be pretty heated. Some say we should grow out of our obligations, like we did in 1950s when our GDP expanded so fast that the proportion of debt became negligible; others would argue that we should rip the band aid off quickly like we did in 1922 when the country went through a quick depression only to emerge roaring and victorious on the other side. However, in the absence of a solid experimental lab it is hard to know which path we should follow or what the unforeseen consequences of massive money printing might be. Teasing the spirits of inflation out of their slumber is kind of like playing with matches in a dynamite factory. You may get much more than you bargained for. Or much less. But no matter what camp you belong to, you would be well advised to pay close attention to what is happening in Tokyo, because whatever ghosts the developed world faces, Japan faces them twice.

After sailing against deflationary headwinds for two decades, its new prime minister Shinzo Abe decided to perform a financial liposuction on the public debt and try to transform the swollen sumo wrestler of non-performing assets into a dynamic gymnast of the regional growth engine. To accomplish a task of this magnitude will of course require some pretty serious out of the box thinking. While up to this point in time the Bank of Japan has been largely conservative, the new governor Haruhiko Kuroda has embarked on unprecedented bout of "easing" (which is a newspeak for "money printing"). And the first results are mildly shocking - to put it diplomatically. Yen has plummeted some 30% and faces a possibility of becoming an illegal tender in the global polite society. Nikkei has almost doubled over the past half years, but like an inexperienced mountain climber became a bit dizzy of late and started wobbling dangerously close to the cliff. And government bonds are acting up, too. After an initial plunge, their yields have shot up and displayed a degree of volatility that halted the corresponding exchanges several times. Such neurotic behavior made them less predictable than a six pack of wild tanukis on a raw vegan diet. And no one knows what kind of sushi will be served next week. Whatever the immediate future holds, it is becoming clear that Japan will be the economic story of 2013 and the whole investing world is fishing in the Asian news streams with baited breath.

Japan is the canary in the Keynesian coal mine. If Kuroda can successfully plug the hole in the dyke without opening five more elsewhere, it will be a signal that the whole system is more robust than we thought and that we can print our money all the way to the monetary Nirvana without destroying its value. However, if adding an extra floor to the existing house of cards collapses the whole structure, it is game over. And not only in the Land of the Rising Interest Rates. Globally.


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