Saturday, 18 December 2010

Mr. Yen: A world recession until 2018.

All hands to the pumps, unless you have a yen for recession until 2018

William Pesek
December 18, 2010

In an era where forecasts by perma-bears have gotten ample attention and vindication, few are as disturbing as this: a world recession until 2018.

It comes from Eisuke Sakakibara, Japan's former top currency official. He is known as ''Mr Yen'' for his ability to move markets. Because Tokyo's revolving-door politics tends to send a new face to each G20 meeting, he is one of the few Japanese constants in market circles. Traders may not know the latest finance minister's name, but they know Sakakibara.

Japan is the master of muddling along, decade after decade, with little growth to show for it. And Sakakibara was a key player when it faced everything from the Asian crisis to the onset of deflation and the banking collapse that led to the demise of Yamaichi Securities.

So, when an economist with Sakakibara's background says ''the world is set for a long-term structural slump reminiscent of the 1870s'', when average global growth was about 1 per cent a year, I cannot help but listen. The reason for the slowdown? Governments are putting fiscal austerity ahead of restoring stable growth.

Yes, there's an eye-rolling quality to a former finance ministry mandarin giving economic advice. After all, officials there did Japan's 126 million people a disservice by punting reform far down the road. They just borrowed and borrowed, leaving Japan with the largest public debt among industrialised nations and no exit strategy in sight.

Yet recent data in the US and Japan and turbulence in Europe suggest a fresh global recession is a distinct possibility next year. If that happens, what levers are realistically available to revive demand? Interest rates are already at, or close to, zero. That leaves increased government spending as the only real way to stabilise things.

The trouble is, there's little support for opening the fiscal floodgates.

One reason is there is already loads of public debt. As of June, Japan's $US5 trillion economy had ¥904 trillion ($10.8 trillion) in debt. Too much debt is wreaking havoc in Europe, where Ireland is the latest domino to fall.

The US is starting to rattle bondholders with its borrowing binge. President Barack Obama's stimulus isn't working the magic economists hoped. Neither is the Federal Reserve, as it goes the way of Japan with quantitative easing.

Worse, in the US and other major economies, is the risk that it may be 1937 all over again. It was then that President Franklin Delano Roosevelt got stingy with stimulus, assuming that the Great Depression was over. The next year the economy was in full retreat.

If Sakakibara is right, the global economy is in deep trouble. He envisions a broad slowdown that might drag on for seven to eight years. China can live a couple of years without US and European growth, but eight?

To head it off, governments need to lift spending. And, for the most part, they aren't. Yet the US can, and should, borrow more. To do that, it just needs to become a bit more Japanese, says Richard Duncan, author of the The Corruption of Capitalism.

There is a single reason why Japan's 10-year bond yields are below 1.3 per cent and Asia's No. 2 economy isn't being downgraded. Since about 95 per cent of Japan's debt is held domestically, there's no risk of capital flight. Japan borrows from its companies and people, an arrangement that is roughly the mirror image of the US.

That so many treasuries are held in China and elsewhere makes the US vulnerable. Duncan, the chief economist at Blackhorse Asset Management, says the US needs another FDR-like new deal to restore growth. Funding one means greater borrowing and the way to do it is by tapping private sector cash, Japan-style.

Such suggestions are likely to fall with a thud on Capitol Hill, which is moving in the opposite direction. Lawmakers calling for Ben Bernanke's head forget why the Fed chairman is taking US monetary policy into uncharted territory. It is because Congress failed to pump enough money into the economy in the first place.

Japan is a cautionary tale. On the surface, the 4.5 per cent annualised increase in third-quarter gross domestic product looked promising. The detail, however, showed deflation is worsening no matter how many yen the Bank of Japan churns into the economy. This is anything but a typical recession, and world leaders are too distracted to see it.

In the US, the focus is on China's currency. While a stronger yuan would be in the best interests of the global economy, it is not the answer to all US problems. Japan is even more obsessed with exchange rates. And Europe is linearly focused on convincing investors that the euro zone won't unravel.

In our time of currency fixation, perhaps a guy called Mr Yen is the ideal messenger.


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