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Japan´s Budget Highlights Abenomics Failure

Global Economy, On the cover, Sin categoría

“Let me tell you a story to chill the bones About a thing That I saw ” Janick Gers Steve Harris

Japan has just published its budget and is on its way to another year of pauper growth and high debt. The estimates of the Government and the Bank of Japan appear, again, overly optimistic.

Japan should matter to all of us. Because it is an example of what we should not do in the rest of the world, after two decades of stagnation and repeating stimulus after stimulus.

The Economist places Japan again among the 20 economies with lowest growth for 2017, and estimates 0.5% GDP growth per year between 2017 and 2021.

This budget is yet another example of Abenomics as a total failure. The plan launched by PM Shenzo Abe to boost growth and fight deflation has delivered, as expected, the poorest results imaginable.

The first problem of the budget is the enormous debt. Revenues cover about 60% of the expenses in the budget. The rest will be financed by issuing more debt, which already exceeds 229% of GDP. Neo-Keynesians who repeat that we should not care “because rates are low” ignore that almost 20% of the budget goes to interest payments even though Japan´s cost of debt is very low (today the 10-year bond is c0.10 %). However, it is dangerous to ignore that the Bank of Japan will “eat” the vast majority of those bonds , and now accumulates more than 35% of the bonds issued by the Government as well as owning the largest share of ETFs in the country. The central bank of Japan is on the path to being the largest shareholder of 55 companies in the Nikkei by end of 2017 and is already one of the top five shareholders in 81 . Seriously, this is as close to a pyramid scheme as one can imagine.

The published budget shows the demographic time bomb facing the country, one that Europe should learn … A rapidly aging population is not solved by monetary laughing gas. More than 40% of the budget goes to pensions and health care.

But above all, monetary policy and government stimulus does not guarantee pensions, which will be cut again in 2017-2018 due to the unsustainability of the system. This should be yet another warning sign to those who say pensions are guaranteed by raising taxes and monetary policy. It does not even happen in Japan.

Of course Japan has a low unemployment, but it has always been that way. And the combination of an ageing population and cultural challenges for immigration keep the work force tight. However, Social Security contributions fail to cover even a portion of the expenditure in public pensions. Additionally, at 36%, Japan has one of the lowest replacement rates in the world (the percentage of the last salary paid as public pension).

And that is the big problem, we try to solve with monetary measures the impact of much more relevant trends, such as demographics. Increasing taxes and disguising the problem, introducing massive useless stimulus plans   only postpones the inevitable.

Some might say “who cares” because there is no inflation. However, real wages in Japan are at a two-decade low and  disposable income continues to erode . The only real beneficiary of Japan’s monetary mirage – which is a slow robbery of the saver under the false pretence of the “social contract” – is the Government, which keeps increasing debt without addressing structural reforms, and the challenges of productivity and “special interests”.

We should see Japan as a warning sign, because in the EU we are copying the same mistakes but without Japan´s labour discipline and technology.

@dlacalle_IA

Daniel Lacalle is PhD in Economics and author of “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

Chart courtesy Japan Macro Advisors

Article published in Spanish in El Español

Why does Trump want more nuclear capability?

Global Economy, On the cover, Sin categoría

“The United States must greatly strengthen and expand its nuclear capability until such time as the world comes to its senses regarding nukes” Donald J Trump

This tweet from President Elect Trump has caused quite a controversy today. Let´s see the facts and reasons behind it.

Nine countries in the world hold a total of 15,375 nuclear weapons. The United States and Russia account for 93 percent of them.

Russia 7,300
USA 6,970
France 300
China 260
UK 215
Pakistan 130
India 120
Israel 80
North Korea 15

So Donald Trump´s message about more nuclear capabilities might sound strange considering the sheer power of the US military. However, there is a reason. If we put together US and Israel as allies and we look at the nuclear programs of other nations, the deterrence factor that the US stockpile represents is diminishing in a world where terror is spreading and China and Iran are under no circumstance transparent about the purpose of their nuclear programs. The size of the stockpile might be insufficient as a defence and deterrence mechanism. We explained here the dangers of the Obama agreement with Iran (read).

But there is another reason. The separation between nuclear for electricity needs and defence ones is too thin. And in the world there are 437 nuclear reactors operating , with another 66 are under construction, mainly in Asia .

Take for example China’s decision to double its nuclear capacity to 23GW more and plans to build another 50GW as part of their search for leadership in nuclear technology. But Russia is following on the same path.

Apart from the 66 nuclear reactors under construction, the world plans to build another 166 , China, India, Russia, the US, and Middle East countries are among the major promoters.

If we add the nuclear capacity planned for the next ten years, there is a relevant risk to the world stability because US potential enemies could increase the stockpile of nuclear weapons at light speed.

Iran, for example, will keep 6,104 IR-1 centrifuges for 10 years, but the Minister for Foreign Affairs, Javad Zarif, has confirmed that Tehran will use their (IR-8) next-generation centrifuges, which enrich uranium up to 20 times faster than the current IR-1s.

The former Director of the CIA Michael Morell and a whole group of geopolitical analysts have warned of the error that the Obama administration made basing the Iran agreement on the number of centrifuges. “5,000 centrifugues is more than enough to build nuclear weapons, but not for an energy programme”.
According to the International Atomic Energy Agency, a nuclear bomb only needs 25 kilograms of enriched uranium U-235. And although it is more difficult to produce 90% enriched uranium, it is not much more complex than the 4-5% uranium required to generate electricity.

The US, which has been lagging in terms of nuclear technology compared to countries such as France, therefore, needs to step up and take action to lead the technology development, both for energy and defence requirements. And make the deterrence factor stronger.

So Trump´s message is both a warning to other nations and an action plan. Unless other countries quickly change their nuclear development plans and accelerate decommissioning, the US will likely expand its defence system. At the end of the day, as Vegetious stated in the Roman times “If you want peace, you need to be prepared for war”.

 

Daniel Lacalle is a PhD in Economics, and author of The Life In The Financial Markets and The Energy World Is Flat (Wiley)

Overcapacity. Another Reason to Reject Demand-Side Policies

Global Economy, On the cover, Sin categoría

@dlacalle_IA

Graph courtesy @ combarro

 

When you listen to some politicians tell us we have to “stimulate domestic demand” as a solution to everything it might sound promising. Since there is poor demand – or at least enough demand to justify the expenses that they consider “adequate” – it has to be “stimulated”.

But what does that mean and why does it not work? Behind these technical words lies the good old cronyist spend. When the only goal is to “stimulate demand” real economic return is forgotten and there is no distinction between value-added projects and white elephants.

Look at the following chart of the US after eight years of demand policies (courtesy of Morgan Stanley), and over $ 24 trillion in fiscal and monetary stimulus.

Graphic 1

 

In China, excess capacity is higher than 30% after eight years of massive stimulus , in Europe it reaches 20% and in Brazil the level of industrial utilization is the lowest since 2009. Is it really a demand problem or the result of excess and overstimulation to create artificial demand? It is clearly overcapacity from excess, as shown by Bloomberg .

China launched a monstrous stimulus plan in 2009 that has left more debt, more excess capacity (up 15 points since the launch) and lower productivity. Rouseff, in Brazil, launched a plan to “reindustrialize” Brazil that generated stagflation and enormous imbalances.

And what have we achieved? Poor capital allocation in “strategic” sectors – decided by governments – causes three negative effects:

– Overcapacity costs . A useless bridge is not irrelevant. It has a cost in working capital, in operating costs and leaves the debt behind. All this is covered with higher taxes paid by the productive and efficient sectors. The result: productive sectors are penalized to support cronyism, disincentives to high productivity sectors and subsidization of low productivity sectors. Add that tax increases reduce consumption, and you have the perfect storm.

– Negative economic impact. Not only these plans do not create more employment, but they reduce potential growth. When low-productivity industries receive the covert subsidy of an “industrial plan”, it does not create more employment. Because overcapacity already exists and the workforce in these sectors does not need to increase. Crony sectors do not hire new workers because they already have them, and the only ones who enter the labor force are in low-skilled jobs. Real wages fall or do not rise. The growth potential of the economy collapses because it is perpetuating itself to the inefficient at the expense of the efficient.

– We moved overcapacity from developed countries to emerging markets. What we build to accomodate for “Chinese growth” meets the reality of what the Chinese build themselves to “keep growing.” An increase, according to Deutsche Bank, of $ 18 of debt for each unit of “created” gross GDP.

Does all this mean that no investments are needed? Not at all . Investment is needed when real economic return is evident. The mistake is to think that the “needs” of investment are dictated by governments that benefit from exaggerating the figures.

 

Daniel Lacalle is a PhD in Economics and author of “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)