Japan’s Prime Minister Shinzo Abe recently addressed parliament stating that he plans to reverse the trend of issuing bonds to raise money but raise more in taxes. Japan cannot beat deflation and a strong currency (yen) if it adheres to the same policy of the past decade.
However his speech comes after the announcement of a $226.5bn stimulus package earlier in the year and this when Japan already has some serious debt issues – public debt that is almost three times the size of the Japanese economy.. He also wants the Bank of Japan to maintain an open-ended policy of quantitative easing (QE) and a doubling of the inflation target – 2%. Hopefully the fiscal stimulus package accompanied by more QE will drive down the price of the yen which will make Japanese exports more competitive. He stated his three arrows of economic policy:
1. Aggressive Monetary Easing
2. Flexible fiscal spending
3. A growth strategy that would induce private investment
Who knows if it will work but Shinzo Abe stated that it is worth the gamble.
The race for countries to devalue their currency (make their exports more competitive) has led to massive increase in monetary stimulus into the global financial system. We are all aware of the three rounds of Quantitative Easing from the US Fed and the indication that they would keep the Fed Funds Rate at virtually zero until 2015. To add fuel to the ‘dim embers’, in 2013 the US is going to inject US$1 trillion into the circular floe. However in China they have also embarked on some serious stimulus:
* More infrastructure development – US$60bn
* Additional credit – US$14 trillion in extra credit since 2009 (equal to entire US banking system)
Nevertheless even with all this artificial stimulus there might be some short-term growth but I can’t see it being sustainable when you consider the extent of global deleveraging. Also IMF figures show that the world saving rates are on the increase (* forecast):
With increased saving rates accompanied by significant austerity measures in many parts of Europe where is the consumer demand going to come from? Unemployment in Spain is 26% and predicted to hit 30% this year- more worrying is 50% of those under 25 are unemployed. Spanish protesters chanted “We don’t owe, we won’t pay” in a march against austerity. So in the US we have massive fiscal stimulus but across the water in Europe it’s all about “tightening the belt” and cutting government spending. Neither seems to be working and are we just putting off a significant downturn for a later date?
It is important that you are aware of current issues to do with the New Zealand and the World Economy. Examiners always like students to relate current issues to the economic theory as it gives a good impression of being well read in the subject. Only use these indicators if it is applicable to the question.
Indicators that you might want to mention are as follows:
The New Zealand Economy
The New Zealand economy expanded by 0.6 percent in the June 2012 quarter, while economic growth in the March quarter was revised down slightly to one percent. Favourable weather conditions leading to an increase in milk production was a significant driver of economic growth over the June quarter. The current account deficit rose to $10,087 million in the year ended June 2012, equivalent to 4.9 percent of GDP. Higher profits by foreign-owned New Zealand-operated banks and higher international fuel prices were factors behind the increase in the deficit during the year. Unemployment is currently at 6.8% but is expected to fall below 6% with the predicted increase in GDP. Annual inflation is approaching its trough. It is of the opinion that it will head towards the top end of the Reserve Bank’s target band (3%) by late next year.
The Global Economy
After the Global Financial Crisis (GFC) the debt-burdened economies are still struggling to reduce household debt to pre-crisis levels and monetary and fiscal policies have failed to overcome “liquidity traps”. Rising budget deficits and government debt levels have become more unsustainable. The US have employed the third round of quantitative easing and are buying US$40bn of mortgage backed securities each month as well as indicating that interest rates will remain at near zero levels until 2015. Meanwhile in the eurozone governments have implemented policies of austerity and are taking money out of the circular flow. However in the emerging economies there has been increasing inflation arising from capacity constraints as well as excess credit creation. Overall the deleveraging process can take years as the excesses of the previous credit booms are unwound. The price to be paid is a period of sub-trend economic growth which in Japan’s case ends up in lost decades of growth and diminished productive potential. The main economies are essentially pursuing their own policies especially as the election cycle demands a more domestic focus for government policy – voter concerns are low incomes and rising unemployment. Next month see the US elections and the changing of the guard in China. In early 2013 there is elections in Germany. The International Monetary Fund released their World Economic Outlook in which they downgraded their formal growth outlook. They also described the risk of a global recession as “alarmingly high”.
Here is a great graphic from the BNZ showing how the NZ dollar performed in September. You could say that it strengthened on the back of notably QE3 from the US Fed and the improving global growth sentiment. Furthermore the NZ economy has performed well under trying circumstances.
June quarter GDP accounts revealed the NZ economy finished Q2 1.6% bigger than where it began the year. That is solid economic growth under ordinary circumstances. But given the ongoing challenging and uncertain global economic environment we should not under sell this achievement. It is the strongest six month expansion we have seen in the past five years. Source: BNZ
It is the US Fed’s intention to buy volumes of mortgage backed securities and keep borrowing rates at near zero (0-0.25%) until the job market and broader economy pick up. Basically they are going to print money until there is some improvement in unemployment figures. Unemployment is at 8.1% and the Fed estimate that it will fall no lower than 7.6% in 2013 and 6.7 in 2014. Inflation is forecast to remain at or below 2% until 2015.
How does it work?
The Fed will buy $40 billion a month in mortgages and will keep doing this until unemployment starts to fall. This will have a couple of effects:
1. It might lower mortgages rates by another 0.25% (already quite low). The 30-year mortgage rate is 3.5% and could go down to 3.25%
2. When mortgage rates go down, the price of houses tends to go up which is beneficial even if you are not refinancing a mortgage
3. Investors tend to move out of low interest earning investments and put their money into stocks. The DJIA closed up more than 200 points and was 625 points off its all-time high.
Impact on NZ$
With the flood of US$ into the market this has put downward pressure on the US$ which will make its export market more competitive and imports more expensive. However risk currencies like the NZ$ and AUS$ have rallied. Looking at the NZ$, this has appreciated considerably against the US$ and will make NZ exports more expensive and NZ imports cheaper. This will not only hurt the export industry as the price of goods become more expensive but the domestic sector have now got to compete with cheaper imports. The NZ$ reached US$0.84 yesterday.
Below is one of many really good presentations on macro and micro economics from the Khan Academy. They are particularly useful for the more theoretical parts of the course and include just about every topic in the AS/A2 syllabus as well as other presentations on current economic issues like the one below. Here they are looking at the difference between quantitative easing in the US and in Japan. Well worth a look.
Bernard Hickey wrote a very valid piece in the New Zealand Herald yesterday. The gist of his writing focuses on the RBNZ and the fact that it should be following other central banks in printing money – quantitative easing. In the 1930’s the RBNZ did inject money into the economy and this helped pull NZ out of the Great Depression.
Most people see the dangers of quantitive easing in the hyperinflation that may follow such an expansion of the money supply. However, if you look at Japan in the 1990’s (the lost decade) interest rates remained at near 0% and the printing of more money didn’t create inflation. Furthermore if you look at more recent examples you see the following:
US Federal Reserve, Bank of Japan, Bank of England, Peoples’ Bank of China, and the European Central Bank have printed a combined US10 trillion in the last 4 years and spent it on bonds, cash injections into banking systems. This normally happens when central banks run out of ammunition to stimulate growth – i.e. low interest rates and they enter a liquidity trap scenario. The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.
Bernard Hickey suggests that it would be much better if the government borrowed from the RBNZ rather than foreign banks and pension funds. Also to print money to fund the deficit which in turn will reduce the value of the NZ$ and therefore make exports more competitive. Click here to view the full article.
It seems ironic that after a global focus to contol inflaton it transpires that what we really need is more. According to Time magazine there are 2 key points why we need inflation:
1. Inflation would shrink the value of the debts both the government and borrowers have to pay, improving our collective balance sheets. Higher salaries would also make it easier for borrowers to pay back their loans helping banks.
2. This might be the more important reason now, inflation pushes people and companies to spend money. If you know prices are going to drop or stay flat, then you will delay a purchase. That’s why most of us are late adopters when it comes to technology. But if you know prices are going to rise, then you will spend your money now. So increasing inflation could stimulate the economy, as well as lower our debts.
Also, according to Paul Krugman, in the long run, it’s very difficult to cut nominal wages. However when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis. Or to put it a bit differently, the long-run Phillips curve isn’t vertical at very low inflation rates.
The fortunate aspect of all this is that creating inflation is not a difficult task. The central banks just have to keep rointing money and buying up government debt. The issue is to do with the long-run and that inflation could get out of control like that in the 1970’s – 20% instead of being below 10%. However it is all to do with inflationary expectations – behavioural economics.
A recent article in the New Zealand Herald by Mark Lister (Craigs Investment Partners) suggested that the best way for an investor to beat inflation is to have an allocation of precious metals in a portfolio. Inflation affects the holders of monetary assets, e.g. bank deposits, savings, loans,government securities – as money loses value, so do these assets. Therefore, savings in real assets such as property are also advisable to beat the inflation monster. However what was interesting about the article was the history of global inflation and money over the last 100 years. Over that time period inflation has averaged 4.5% but it has been the last 10 years that has seen it accelerate significantly.
The table shows inflation rates of industrialised countries since 1900. Switzerland is the only country to have maintained an average inflation rate below 3% over the time period. One has to ask why other countries have found it so hard to keep inflation under the 3% level. Up until the mid 1970’s most major currencies were backed by precious metals. What it bascially meant was that a country could only print more money if it increased its stock of gold or other precious metals – the currency was backed by these precious metals. The rationale here was that the notes and coins could be exchanged for precious metals which meant that you couldn’t just print more money (quantitative easing) like they have been doing over the last couple of years. It was in 1971 when President Nixon suspended the convertibiity of US dollars into gold and by 1975 most other developed countries had followed suit. This led to a new era of just prinitng more money and currencies become known as fiat currencies – no inherent value. The term derives from the Latin fiat, meaning “let it be done” or “it shall be (money)”, as such money is established by government law. The key aspect about fiat money is the fact that its value relies entirely on the confidence the public have in it.
Up to 2000 Switzerland still kept linking its currency to gold and it was only after a referendum that authoriites loosened the requirement to hold a certain amount of gold as a back-up to paper money. Today, it’s as easy as a few extra numbers entered on a computer keypad. Printing money doesn’t achieve much other than inflation. There is still the same amount of goods and services to go around, but now there is more money chasing the same amount of goods, so the price simply goes up in reaction, which in turn makes your money worth less in terms of its purchasing power.