“Santa Claus territory.” That is how Charles Gave of Gavekal Research views renewed debate about how a concept known as “Modern Monetary Theory” can save capitalism.
There’s nothing modern, of course, about the idea that a government can borrow with abandon in its own currency, unconstrained by deficits. It’s not just that its origins can be traced back 100 years – some argue 1,000. It’s that Japan has been toying with MMT for two decades now.
In 1999, the Bank of Japan became the first major authority in modern history to drive interest rates down to zero. A couple of years later, it pioneered the quantitative-easing that peers from Washington to Frankfurt would eventually adopt.
What’s truly astounding is the docility of bond yields. Try as they may, punters haven’t been able to set Japanese government bond prices in nearly 20 years. That’s because the central bank dominated the bond market.
The MMT rabbit hole
Japan proves that so long as a government borrows at home, and does so skillfully, the laws of financial gravity lose relevance. Yet it also stands as a cautionary tale for other developed economies scurrying down the MMT rabbit hole.
Nobel laureate Paul Krugman and Larry Summers, former US Treasury secretary, have written dismissively of the theory. Count Krugman among those who subscribe to Gave’s Santa Claus quip.
Krugman’s bottom line, spelled out in a recent New York Times column: “You don’t have to be a deficit scold or debt-worrier to believe that really big progressive programs will require major new revenue sources.”
Tell that to Japan, though, whose government debt in 2018 hit the US$10 trillion mark, an ominous milestone. In the same year the nation’s population saw a record decline. Despite all this, 10-year yields are -0.04%. Punters, in other words, are effectively paying Tokyo for the opportunity to hold its debt.
“MMT heaven!” you might cry – until you count the epic costs of policy complacency. Because Japan avoids the market consequences of its profligacy, policymakers feel less urgency to implement structural upgrades needed to boost competitiveness.
Borrowing versus reforming
For 20 years now, Tokyo used aggressive monetary easing, a weaker yen and ever-bigger fiscal-stimulus programs to support growth. That reduced incentives for a succession of governments to do the heavy lifting on the supply side and open protected sectors.
This, too, has been the case since late 2012, when Prime Minister Shinzo Abe rolled out a seemingly aggressive assault on deflation. Mostly, though, he relied on old school easy money and public-works projects. A smattering of steps to tighten corporate governance and lower trade barriers, sure.
But nothing sufficient to generate strong growth with massive stimulus. And on Abe’s watch, the BOJ’s balance sheet exceeded the size of Japan’s entire $4.9 trillion economy.
The real problem with MMT is that it assumes a level of multitasking that has proven beyond Tokyo. It assumes all that borrowing will be put to productive use – to increase productivity, incentivize innovation and strengthen the labor pool.
The problem with Abenomics always was the absence of imagination. It was merely a list of reforms Tokyo should’ve implemented 10 or 15 years earlier, not a new recipe for prosperity. Now, as 2019 unfolds and Donald Trump’s trade war hits Asia, Japan is uniquely vulnerable. That’s because Tokyo consistently put off steps to wean the economy off exports and a weak yen, favoring massive borrowing instead.
Purists might take exception with the argument that modern Japan is the best case study here. To economist Gave, other, more historical, examples warrant attention. “Financing government spending by printing money is as old as paper money itself,” he says. “The Song Dynasty did it. The Weimar Republic did it. And Robert Mugabe and Nicolás Maduro both did it. But perhaps the closest historical parallels to today’s MMT proposals are to be found in 18th century France – two of them in the same century!”
Japan’s journey has its place, though. As with everything from a shrinking population to learning to live without nuclear reactors, Japan is often humankind’s laboratory. If we’re looking for a modern mainstream economy proving that a debt-to-gross-domestic-product ratio of 250% needn’t cause a crisis, it’s Japan.
In a March 12 Bloomberg op-ed, Jim Bianco explored former Federal Reserve Chairman Ben Bernanke’s 2006-2014 tenure – and afterward – with an eye on Tokyo’s experience.
“Some would argue that Bernanke has already laid out the framework for how MMT could work,” wrote the president of Bianco Research. “Bernanke traveled to Tokyo in July 2016 and suggested a way to stimulate the Japanese economy. He said the Ministry of Finance, Japan’s equivalent to the US Treasury Department, should issue non-marketable perpetual bonds with a zero-coupon that the Bank of Japan would buy with printed money. The Japanese government could then use the funds from these bond sales to stimulate the economy.”
Tokyo may be mulling just that as growth slows anew. Thanks to all that borrowing these last 20 years, Tokyo felt less urgency to raise its economic game. The costs of two decades of delay are now catching up with Japan. The bottom line, Gave says, is that “unfortunately, Santa Claus doesn’t exist.”