Keynes Was a Failure in Japan – No Need to Embrace Him in Europe

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Tokyo Ginza on SundayDraghi’s volte-face two weeks ago has emboldened the Keynesian majority in the media and in economic research departments. It has injected new life into their relentless campaign for yet more state intervention in the Eurozone economy. It wasn’t anything the ECB actually did (or announced) that initiated this new euphoria. As usual, the measures fell short of what the tireless advocates of “stimulus” demanded. To the true Keynesian, no interest rate is ever low enough, no “quantitative easing” program ever ambitious enough, and no fiscal deficit ever large enough. But with his talk of “stimulating demand” and his calls for “fiscal flexibility”, Draghi was finally speaking the Keynesian lingo. It was this that got hearts racing.

“Choirs of angels must have sung over the statement that the eurozone has a problem with demand,” enthused Martin Wolf, head guardian of the Keynesian faith at the Financial Times, so aptly called the “pink Times”. Remember, that a lack of demand is, in the Keynesian religion, the original sin and the source of all economic troubles. “Aggregate demand” is the sum of all individual demand, and all the individuals together are not demanding enough. How can such a situation come about? Here the Keynesians are less precise. Either people save too much (the nasty “savings glut”), or they invest too little, maybe they misplaced their animal spirits, or they experienced a Minsky moment, and took too much risk on their balance sheets, these fools. In any case, the private sector is clearly at fault as it is not pulling its weight, which means that the public sector has to step in and, in the interest of the common good, inject its own demand, that is “stimulate” the economy by spending other people’s money and print some additional money on top. Lack of “aggregate demand” is evidently some form of collective economic impotence that requires a heavy dose of government-prescribed Viagra so the private sector can get it’s aggregate demand up again.

[Hear: Louis-Vincent Gave: Euro Crisis 2.0]

Wolf thinks deficits should be higher, preferably as a result of public investment and tax cuts, and of course, there should be some proper quantitative easing, not just the meagre purchases of €750 billion of asset-backed securities the ECB promised at the last meeting. (Sadly for Draghi, the goal posts on what constitutes real QE have been secretly moved. Now, only buying large chunks of government bonds is deemed worthy of the label.)

In fairness to the ECB president, it should be mentioned that he also spoke of the need for structural reform, but as usual, this is a bore for the Keynesians. “My view is that structural reforms are mostly irrelevant for the recovery,” opines Wolfgang Münchau, Wolf’s colleague at the FT. What Münchau wants is, of course, more fiscal spending and more money printing. Structural reform – the belief in which he considers “cranky” – should only be thrown into the mix as a bribe to keep the Germans happy. He envisions some fiscal and monetary “carpet bombing” to force the economy into higher growth, damn it!

To commentators like these the prospect of Germany running a balanced budget (potentially in 2015, it would be the first since 1969) is bound to cause apoplectic seizures. According to the Wall Street Journal, Germany’s leftish weekly Der Spiegel called the goal a “fetish”, declaring that “an investment program for Germany would be an act of European solidarity.” The FT’s Wolf diagnoses that the deficit forecast for the Eurozone as a whole of “just 2.5 percent” means that the fiscal stance is “too tight”.

Meanwhile in Japan

Things must be much better in Japan then, a place evidently not run by the some inflation-fearing and austerity-obsessed Teutons, and for the past 20 years the veritable motherland of “fiscal flexibility.”

“Japan ran fiscal deficits equivalent to 8.4% of GDP last year, and had a public sector debt of 245% of GDP, both (!) the highest among major economies,” the Wall Street Journal reported last week (my emphasis). Well, that must have injected a lot of aggregate demand into the economy!

Since Japan’s easy-money-bubble of the 1980s popped in 1989, the country has obediently implemented the entire tool book of Keynesianism, and has done so repeatedly, but in particular it employed ad nauseam the proposal of Wolf, Der Spiegel and Münchau of “public investment” to stimulate the economy – to no avail, other than causing ever larger deficits.

Drawing from IMF sources, wikipedia compiled the following list of suicidal stimulus policies: “Between 1992 and 1995, Japan tried six spending programs totaling 65.5 trillion yen and cut income tax rates during 1994. In January 1998, Japan temporarily cut taxes again by 2 trillion yen. Then, in April of that year, the government unveiled a fiscal stimulus package worth more than 16.7 trillion yen, almost half of which was for public works. Again, in November 1998, another fiscal stimulus package worth 23.9 trillion yen was announced. A year later (November 1999), yet another fiscal stimulus package of 18 trillion yen was tried. Finally, in October 2000, Japan announced yet another fiscal stimulus package of 11 trillion yen. Overall during the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed to cure the recession. What the spending programs have done, however, is put Japan’s government in poor fiscal shape.”

[Read: Bank of Japan Refrains From Deepening Stimulus]

Oh, but the list is not complete without this additional bon mot:

“Japan’s expansionary monetary policy failed to achieve recovery.”

Policy rates have not been above 1 percent in Japan for 18 years. The country has for more than 20 years been the laboratory rat of applied Keynesianism – and to say that the promised results did not quite materialize seems a gross understatement.

To be able to ignore the abject failure of Keynesianism in Japan the commentariat has adopted the meme that inflation is too low for fiscal pump priming to work. It’s the deflation, stupid -  although the consumer price index has hardly changed over the past 10 years in Japan. In stark contrast to what the news media want you to believe, Japan had pretty much price stability. It is true, that the Bank of Japan has not kept the printing presses at full throttle consistently, and has varied bouts of QE occasionally with a calmer policy approach. Keynesianism can evidently only deliver the goods if reckless fiscal spending is paired with reckless money printing. And that is part of the appeal of “Abenomics”, which started early in 2013 with a promise to end “deflation” (price stability) to the cheers of the global Keynesian fraternity. Over the past 12 months, Japan not only had the biggest fiscal deficit, it also had the fastest growing central bank balance sheet in the developed world. If anybody tried Herr Münchau’s carpet bombing approach it is Japan.

Here is the Wall Street Journal again:

“Revised data…showed that the country’s gross domestic product contracted an annualized 7.1% in the April-to-June quarter from the previous three-month period, as businesses as well as consumers retrenched after the government raised the sales tax.”

What? – After 20 years of the most extravagant fiscal stimulus in history and on the back of “all-in” money printing, a 3 percent hike in the sales tax causes the economy to nosedive?

“Even with the negative impact of the higher sales tax making a sharp fall in GDP a foregone conclusion, analysts still expressed concern. …’Everything buckled – consumption, capital spending, housing investment and infrastructure. This is very bad,’ said Etsuro Honda, an economic advisor to Mr. Abe, in an interview.

There is now talk of postponing the next tax hike which is not going to do much to fix Japan’s real problem: a growing debt load.

But hey, what about doing some extra “public investment” to stimulate the economy?

Hardly a Surprise

I cannot exclude that all this lunatic hyperactivity may result in the odd calendar quarter occasionally showing some better headline growth. Maybe the Japanese even get their wish for proper inflation some day, and higher yields and a falling currency. (Be careful what you wish for!) We can still safely exclude that this program of Keynesianism on steroids will someday unshackle Japanese animal spirits and release the economy on a path of healthy, balanced and self-sustaining growth. These policies are part of the problem. They are not the solution.

None of this should be a surprise. To find out that Keynesianism must fail we do not need the real-life example of Japan. A proper look at its weak theoretical foundations should have sufficed. That is what a journalist of a different caliber did already more than 50 years ago: the incomparable Henry Hazlitt, who was principal editorial writer on finance and economics at the New York Times from 1934 to 1946 (oh to think of who holds that position now!!), and who published his critical dissection of Keynes’ General Theory in 1959. Hazlitt knew and could explain why Keynesian policies must fail. What a different type of journalism Hazlitt gave his readers when compared to the unthinking and unrelenting carping about the need for more “stimulus” we read everywhere today.

What is probably most galling about the Keynesian media onslaught is that, with a brazenness that is reserved for the truly deluded, these commentators invoke the spectre of a “Japan-like lost decade” in Europe if their advice is not heeded. It boggles the mind.

Notwithstanding the new love-in between Draghi and the Keynesians, I believe there is still too much resistance to outright Keynesianism in Germany and among the Northern contingent of the Eurozone. These countries broadly remain of the eminently sensible view that without meaningful structural changes in France and Italy, without reforms that increase their competitiveness, lower their structural unemployment, and stabilize their fiscal outlook, Germany and Co. remain at risk of paying for any fiscal troubles in these countries in the future. The market is of the view that the debt load has already largely been communalized via the ECB. Remember Draghi’s dangerous promise to “do whatever it takes.” This is deeply unpopular in Germany. It is also not that simple. When one of the big countries faces its Greek moment Draghi will find out that he cannot do that much after all. I believe the German government will continue to drive home the point that the French and Italian governments have to do their homework. There is little appetite for any fiscal adventurism a la Keynes.

But Mr. Wolf and Mr. Münchau should not despair. They can always enjoy the wonderful successes of applied Keynesianism in Japan.

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