Japan’s Last Stand

There is a popular American military term called a “last stand”, which is meant to describe a situation where a combat force attempts to hold a defensive position in the face of overwhelming odds. The defensive force usually sustains very heavy casualties or is completely destroyed, as happened at Custer's Last Stand. General Custer, misreading his enemy’s size and ability, fought his final and fatal battle of Little Bighorn; leading to complete annihilation of both himself and his troops. 

The Japanese government is now partaking in a truly incredulous measure to expand its QE program in a desperate attempt to de-value its currency and re-inflate asset bubbles around the world.  In other words, Japan is constructing its own version of a “last stand”.

In a final attempt to grow the economy and increase inflation, Japan announced a plan to escalate its QE pace to $700 billion per year.  In addition to this, Japan’s state pension fund (the GPIF), intends to dump massive amounts of Japanese government bonds (JCB’s) and to double its investment in domestic and international stocks.  All this in a foolish attempt to increase inflation, which Japan mistakenly believes will spur on economic growth.  But these failed policies have now caused Japan to enter into an official recession once again, as GDP fell 1.6% in Q3 after falling 7.1% in the previous quarter.

Japan is now guaranteed to be successful in the total destruction of its currency, the complete destruction of its economy and the collapse of the markets it is attempting to manipulate around the world.   To fully understand its misguided reasoning, we have to explore how Japan got here in the first place. 

Coming out of WW II, Japan enjoyed a three-decade period referred to as its “Economic Miracle”.  This “miracle” was instigated by a booming post-war export economy helped by prudent fiscal policies, which was meant to encourage household savings. Japan’s standard of living soared among the highest in the world.  Japan sailed into the 1980’s on the wave of robust economic growth.  However, if we have learned one thing after all these years, it’s Government’s insatiable need to meddle with the free market, even when they don’t need to.  Accordingly, the 1985 Plaza Accord was sought to weaken the U.S. dollar and German Deutsche Mark against the yen.  The Bank of Japan, in an attempt to offset the rising yen, drastically reduced interest rates. The BOJ’s loose monetary policy in the mid-to-late 1980s led to aggressive speculation in domestic stocks and real estate, pushing the prices of these assets to astonishing levels. From 1985 to 1989, Japan’s Nikkei stock index tripled to 39,000 and accounted for more than one third of the world’s stock market capitalization. 

By the late 1980s, Japan had transitioned from a “miracle” economy to its infamous bubble economy, in which stock and real estate prices soared to stratospheric heights driven by a speculative mania. Japan’s Nikkei stock market hit an all-time high in 1989, then crashed, leading to a severe financial crisis and long period of economic stagnation that Japan is still entrenched in. It has now become known as Japan’s “Lost Decades.”

Shortly after the bubble burst, Japan embarked on a series of stimulus packages totaling more than $100 trillion yen--leaving an economy that was once built on savings to eventually be saddled with a debt to GDP ratio that now exceeds 240%--the highest in the industrialized world.  Making matters worse, the BOJ has more recently engaged in an enormous campaign to completely vanquish deflation, despite the fact that the money supply has been in a steady uptrend for decades.  At the end of 2012, we were introduced to Abenomics, which is Premier Shinzo Abe’s plan to put government spending and central-bank money printing on steroids. His strategy is crushing real household incomes (down 6%) and caused GDP to contract 7.1% in Q2.   

With the rumored delay of its sales tax, Japan is clearly making no legitimate attempt to pay down its onerous debt levels.  Therefore, one has to assume this huge addition to their QE is an attempt to reduce debt through devaluation and achieve growth by creating asset bubbles larger than the ones previously responsible for Japan’s multiple lost decades.  This will not return Japan back to the days of its “economic miracle”, where the economy grew on a foundation of savings, investment and production. 

The sad reality is that Japan is quickly surpassing the bubble economy achieved during the late 1980’s. Its equity and bond markets have become more disconnected from reality than at any other time in its history. The nation now faces a complete collapse of the yen and all assets denominated in that currency.

This is clearly Japan’s last stand and there is no real exit strategy except to explicitly default on its debt.  But an economic collapse and a sovereign debt default on the world’s third largest economy will contain massive economic ramifications on a global scale. Japan should be the first nation to face such a collapse. Unfortunately; China, Europe and the U.S. will also soon face the consequences that arise when a nation’s insolvent condition is coupled with the complete abrogation of free markets by government intervention.

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Michael Pento is the President and Founder of Pento Portfolio Strategies and Author of the book “The Coming Bond Market Collapse.”