Revolutionary Japan Is Suddenly the Centre of World Affairs

Ambrose Evans-Pritchard

China and Japan are rattling sabres over the Senkaku/Diaoyu islands. Both have graduated to fighter jets, and China has mobilized the East China Sea fleet for live ammo drills. China is testing Washington's willingness to risk conflict to back Asian allies. There is a possibility that the world's three largest economies could come to blows.

Against this backdrop, Japan’s economic policy revolution seems tame, yet it could have powerful effects throughout the world’s asset markets and trading system. Premier Abe has vowed an all-out assault on deflation, going for broke on multiple fronts with fiscal, monetary and exchange stimulus.

Abe has lost patience with the Bank of Japan; now it will do what it’s told, the first of the big central banks to be stripped of its independence. There will be an inflation target of 2%, to be achieved by unlimited bond purchases.

The liquidity effects of this by the world's top external creditor could seep into everything, a sort of ‘carry trade’ on steroids. The IMF warns that Japan has reached the point where even a relatively small rise in borrowing costs could set off havoc.

Abe is taking a huge gamble. Japan’s trade surplus has evaporated, and will not recover soon after the closure of the nuclear industry. The savings rate has fallen to 2% from 15% in 1990; the work force is shrinking. The state pension fund has become a net seller of government bonds as the aging effect reaches a critical point; Japan's banks have become buyers of last resort instead, pushing their holdings to 85% of GDP.

Japan has a safe-haven currency that strengthens in times of trouble when least wanted. But if Japan buys foreign bonds on a mass scale to suppress the yen, Tokyo will be blamed as the aggressor in the outbreak of currency wars. Others will retaliate.

Japan's experiment cuts both ways for the rest of the world: the reflation blitz helps lift the global economy out of the doldrums, but yen manipulation snatches market share, incites protectionism and takes us into a new world of ‘actively managed exchange rates.’

source: telegraph