Thesis 2012 Financial Repression

Thesis 2012 Financial Repression-33
The story begins with Japan’s post-war economic miracle.In order to rebuild its economy after the devastation of World War II, the Japanese government adopted an export model to boost export growth and import know-how.By mid-1986, the rising yen had forced Japan into a recession (because the stronger yen harmed the country’s exports).

As the original “Asian Tiger,” Japan employed this strategy to great effect over the years, growing GDP sharply on the back of strong exports.

As long as GDP and exports are growing, this model works.

But when GDP stops growing and exports slow, the model fails.

The point of failure for Japan was when its easy monetary policy stimulated a real estate and stock market bubble instead of fueling exports.

And because of this persistent trade surplus, Japan has built up a large portfolio of foreign currencies.

Thesis 2012 Financial Repression

These foreign currencies are then invested in foreign assets (e.g., U. Treasuries) earning Japan a steady stream of income.The BOJ was ferociously trying to stimulate the economy with aggressive easing.In addition to low rates, the BOJ maintained high levels of money supply and credit growth, which drove the creation of the bubble as illustrated in Figure 2.Japan invested heavily in education, research and manufacturing.A key element of the export model is, of course, accommodative monetary policy whereby a country uses credit creation, infrastructure development, and lower-than-market interest rates (known in monetary parlance as “financial repression”) to focus the country on exports.As you can see in Table 1, this is the answer to the original question.This cash flow cycle is how Japan has funded itself over the past 22 years. The Japanese debt crisis is being spawned by a burgeoning fiscal deficit.Yet Japan has — thus far — somehow avoided a debt crisis. In a country where interest rates have moved slowly but consistently over the past two decades, investors who have gambled on the thesis that Japan’s financial structure is unsustainable have been forced to learn one of the harshest lessons of investing: There is little difference between being early and being wrong.In fact, many investors have bet against Japan over the years . So, how exactly have interest rates in Japan remained so stubbornly low in the face of a persistently stagnant economy and high and growing debt? If not, when does Japan cross the event horizon for a major shift in fortunes?In 1985, the major economies of the world (United States, Japan, West Germany, France, and the United Kingdom) coordinated the Plaza Accord to reduce the value of the dollar relative to other major currencies (including the yen) with the specific intent of reducing trade imbalances.In the 24 months after signing the accord, the yen appreciated by 50%.


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