“Red warning lights are flashing on the dashboard of the global economy,” remarked David Cameron last weekend. The Prime Minister was highlighting, rightly, the plethora of economic and geopolitical risks currently stalking the world, all of which threaten the UK’s fragile recovery.
Referring to a “dangerous backdrop of instability and uncertainty”, Cameron pointed to conflicts in the Middle East and Ukraine, ebola, a slowdown among the big emerging economies of the East and, with a flourish, “a eurozone that’s teetering on the brink of a possible third recession”.
This outburst of economic honesty had little to do with any new-found interest in the dismal science on the part of our Prime Minister, of course, and everything to do with the upcoming Autumn Statement on Wednesday 3 December. The dire state of our public finances means that Chancellor George Osborne’s Commons set piece will likely be light on spending giveaways and tax cuts. So the Tories are getting their spin in early, shoving the blame onto the rest of the world.
It remains true, though, that various global woes are now undermining the UK’s recovery, slowing our exports and generally dulling investor confidence. I’m sure this is a message – “it’s their fault, not ours” – that the Tories will be plying heavily in the run-up to the Autumn Statement and beyond. But the thing is that just a few hours after Cameron opined, his economic missive was already out of date. Because we must now add yet another risk to the litany of potential dangers dragging down global growth and which could even spark a 2008-style systemic meltdown. And that additional risk is Japan.
The Japanese economy contracted at an annualized rate of 1.6pc between July and September, we learnt last Monday. This return to recession was, to say the least, a shock. The consensus forecast was for an expansion of around 2pc during the third quarter. That’s the target Prime Minister Shinzo Abe has set in the hope that economic expansion will help tackle Japan’s national debt – which stands at around 240pc of GDP. Even this eye-watering debt ratio is set to go higher, with Japan now in recession for the fourth time since the onset of the financial crisis.
Since these disastrous growth data were published, Japanese politics has been upended. After just two years in office, the Prime Minister on Friday dissolved parliament, calling a snap election to seek a fresh mandate for “Abenomics” – his strategy of reviving Japan’s moribund economy with a mix of super-easy money, government spending and structural reform.
With the recent rise of Japan’s sales tax from 5pc to 8pc being widely blamed for hindering recovery, Abe also delayed for at least 18 months a planned further increase to 10pc – even though that tax hike was previously presented as central to his debt-reduction strategy. Despite that reprieve, voters aren’t impressed. Polling data suggests more than two-thirds don’t understand why Abe has called a shotgun election.
Since Cameron issued his verdict on the global growth outlook, we now know the world’s third-largest economy has plunged back into recession. Why should that matter? Japan has been in and out of recession since the early 1990s, after all, with its infamous “lost decade” now firmly re-labelled “the lost 20 years”. Given that Japan has long been gripped in a vice of falling wages and economic contraction, why should a few more years make any difference to us?
The reason why we should worry is that Japan’s program of quantitative easing is now wildly out of control, so much so that the country represents a major risk not only to itself, but also the rest of the world. With growth now reversed, and the power-crazed Abe determined to consolidate his hold on office, the danger is that the supine mandarins at the Bank of Japan turn up the dial to a degree that defies all credibility, sparking a crisis of confidence that spreads around the world.
This column has often criticised the unprecedented extent to which the Western world has relied on the printing of virtual money to try to secure a meaningful economic recovery. For QE, on the scale we’ve used it, is deeply counter-productive – and that’s before you consider the potential chaos on financial markets when the monetary spigot is closed and pumped-up asset prices crash back to earth.
Rubbish, I hear some of you say, especially those who work for an investment bank or in The Treasury. The US Federal Reserve just ended QE and nothing happened. Financial markets sailed on. Yes, but almost no-one who knows anything about financial markets really believes that the party really is over. Any sign of serious trouble on Wall Street, and the Fed will launch QE anew.
Aside from that, the European Central Bank is widely expected soon to follow its Anglo-Saxon counterparts, mimicking the US and UK forays into massive monetary creation. And even before that, the funny-money baton has now anyway been passed back to Tokyo, soothing concerns that global equity markets will lack liquidity any time soon. For the Bank of Japan is now expanding its balance sheet on a quite extraordinary scale.
Immediately after the subprime crisis, Japan was actually relatively slow out of the blocks when it came to “extraordinary monetary measures”. Having practised QE in the past, the Bank of Japan’s balance sheet was already equivalent to around 20pc of GDP, compared to 6pc at The Fed and The Bank of England. Once Lehman collapsed in 2008, the UK and US rapidly expanded base money to 25pc and 30pc of GDP by mid-2013, a four-fold and five-fold increase respectively.
Over the same period, Japan grew its central bank balance sheet to around 40pc of GDP, a two-fold rise – still massive, but smaller by comparison. That’s why the yen strengthened, causing howls of protest from Tokyo’s all-powerful export lobby. Since then, though, Japanese monetary policy has gone into hyperspace.
Under Abe, the Bank of Japan has expanded its balance sheet from 40pc to around 50pc of GDP over about 18 months. Then, at the end of October, Abe rolled the dice again, announcing a boost to a quite incredible 70pc of GDP over the next three years. By that time, Japan’s monetary base will be close to the same size as that of America, even though the US economy is three times bigger and home to two-and-a-half times more people.
This is preposterous. The Bank of Japan – and its supporters on financial markets from London to New York and beyond – claim Tokyo is trying to escape deflation and boost its economy. But Japan isn’t refusing to grow because it needs more QE. The funny money, after all, barely enters the “real economy”. While it boosts shares prices, much of it just end up as excess reserves parked by otherwise insolvent banks and financial institutions at their respective central banks.
QE does almost nothing to secure meaningful, sustainable growth. It’s all about competitive currency depreciation and governments avoiding tough decisions – as central banks buy sovereign bonds. To say nothing of back-door bank bail-outs. This is as true in Japan as it is everywhere else, only moreso.
The danger is, though, that Japan’s QE programme is now so vast that it could cause a wave of panic – particularly if rising Japanese interest rates spark fears of further monetization, causing a sharp fall in the yen that then leads to a downward spiral. The “red warning lights” are certainly flashing. Cameron was right – and probably more than he knew.