Japan has been experimenting with Quantitative Easing since the 1980's and more recently in 2016 with negative interest rates. Are we heading for similar outcomes in Australia? What can we learn about the Japanese experience thus far?
Japanese Economic History
In the year 1980, the Vapors released their hit song, "Turning Japanese," quickly hurling the English band to top 10 charts around the world and earning a position as an instant cult-classic.
Japan had made a resounding cultural and economic comeback post-WWII, averaging greater than 4% per annum GDP growth for most of the 1970's and 1980's, becoming the second largest economy in the world and was forecast to overtake the US for economic hegemony.
Japan's strong economic growth in the second half of the 20th century ended abruptly in the early 1990's. Excessive loan growth quotas directed by the Bank of Japan (BoJ), the Japanese equivalent to the Reserve Bank of Australia (RBA), fueled an asset price bubble akin to the Japanese version of the Global Financial Crisis whereby credit was easily available despite your ability (or inability) to repay the loan. This subsequently resulted in Japanese banks needing to be bailed out.
How did they bail them out? The BoJ printed money. Lots of money. Otherwise known as Quantitative Easing.
What followed was a period of economic turmoil originally titled, "The Lost Decade," referring to the negative economic growth experienced in the 1990's, although later re-labelled, "The Lost Score," to incorporate the period from 1991 to 2010, and likely to be further re-categorised to incorporate the last decades negligible growth.
No stranger to pioneering unconventional monetary policy such as Quantitative Easing, the BoJ since 2016 has been experimenting with negative interest rates to try and stimulate their economy back to positive economic growth.
Quantitative Easing has worked for America
During the GFC, the US Federal Reserve implemented an expansive Quantitative Easing program that successfully bailed out their banking sector and ultimately narrowly averted a catastrophic financial meltdown (certainly less disastrous than the Japanese experience).
Why did it work for America and not Japan?
The US holds the coveted position of being the worlds reserve currency. Some 82% of international transactions are settled in US Dollars. By comparison, less than 2% of international transactions are settled in Japanese Yen (and interestingly less than 2% of international transactions are settled in Chinese Yuan, the world's second biggest economy).
As Australian's, when we want to buy a Japanese made Sony TV, our Australian Dollars are converted to US Dollars, which are then converted to Japanese Yen. This is the case for the vast majority of international trade and ultimately results in all countries needing to acquire US Dollars to settle transactions.
So when the money printing presses are heating up in America, the world flocks to acquire US Dollars. Importantly for America, their real advantage is that they are able to export their inflation to the rest of the world.
You and I are paying for the US's inflation blowout. We are their shock absorbers, cushioning their economic blow.
No other country in the world holds this significant advantage.
Australian Monetary Policy
As a response to the economic impacts of COVID-19, for the first time in our history, the Reserve Bank of Australia along with many developed economies has embarked on a program of Quantitative Easing, announcing the purchase of up to $90 billion in Australian Government Bonds.
The RBA currently holds some 9% of all Australian issued Government Bonds. We are a far cry from the Japanese experience, where the BoJ owns 100% of Government Bonds, as well as holding a considerable swathe of the Corporate Bond market (the BoJ directly lends money to Japanese companies, with a current debt ceiling of approx $20 trillion Yen - some $284 billion AUD).
The Japanese have been running these style of unconventional programs since the 1980's without much success and Australia is only at the beginning of our QE journey. In 2016, the BoJ went one step further by implementing a policy of negative interest rates. To date, these policies have largely been dubbed ineffective.
We know QE has previously worked for America because of their world reserve currency status, but why do the RBA think it will work for Australia?
The answers at this stage remain unclear, however Quantitative Easing in theory is supposed to be a temporary measure; with the money ultimately needing to be re-paid and destroyed. As the Japanese experience clearly highlights, protracted periods of printing money with a debt fueled growth agenda is unsustainable and detrimental to the economy.
Japan are certainly beyond the point of ever being able to repay all their debt and destroy the money they have printed.
Negative interest rates also haven't helped.
The Australian economy has been dithering with negligible economic growth for several years now. Is this the beginning of our "Lost Decade" or worse still, our "Lost Score?"
We certainly hope not.
Mel Pikos
Managing Director
Muse Capital