Globally, inflation has been a headline story for months, and will likely continue for the foreseeable future. On November 2nd, the Fed raised interest rates by 0.75 percentage points for the fourth consecutive time, only a few days after the ECB did the same.
Central banks tighten monetary policy to bring inflation under control in an attempt to increase savings and reduce spending. This usually works well in an environment of “good inflation”, when prices increase because demand is higher than production capacity. This is good because, in this case, the economy is usually booming, and unemployment rates are low.
Similar to the OPEC oil embargo in the seventies, in 2022, due to the Russia-Ukraine war, we saw inflationary pressure spiking due to a supply shock in the oil and gas markets.
But there is also “monetary inflation”, which occurs when the supply of money outpaces the value of goods and services. In other words, there is an imbalance between the money available in the system and the money needed for real economic activity. This oversupply is usually flowing into financial markets. As a consequence, the stock markets are booming as asset prices increase.
This oversupply has been building up for years now. Printing money, or quantitative easing, has been used throughout central banking history. More recently, since the early eighties, Fed rates have continuously been pushed down.
After the global financial crisis of 2008/9, it was increasingly applied by the US and ECB, including the Bank of England, up until the point where interest rates hit high rock-bottom. Then, COVID-19 led to another massive government bond buy-back programme; consequently, the Fed balance sheet, for example, more than doubled from $4.3 trillion in March 2020 to over $8.8 trillion in September 2022.
Is Japan different?
Yes and no. Low-interest rates are nothing new for the Japanese as for the last 25 years, rates have never been higher than 50 basis points. And since 2016, the Bank of Japan (BoJ) has pegged the yield on ten-year government debt near zero. From 1999 to 2012, Japan suffered deflation, and for most of the 2010s, inflation was only slightly positive. Still well below the central bank’s 2% target, therefore, a stimulating monetary policy seemed reasonable.
In its last meeting, the Bank of Japan kept its key short-term interest rate at -0.1% and that for 10-year bond yields at around 0%. At the same time, inflation is forecasted to hit 2.9% in 2022, while GDP growth is expected to reach 2% this year and 1.9% in 2023. The BoJ reiterated it would take extra easing measures if needed while continuing to buy “unlimited” amounts of bonds.
Buying more bonds would add to roughly 45% of national debt already held by BoJ, bearing in mind that Japan has the highest debt-to-GDP-ratio of any developed nation, standing at over 2.5x national GDP, at about the same level seen during the Pacific War in the forties. By comparison, in the US, debt-to-GDP stands at ~130% if we don’t include unfunded debt of approximately 172 trillion, which is another discussion for another time.
Therefore, it comes at little surprise that the Japanese Yen (JPY) has been under pressure as the widening interest rate spread between the USD and JPY has been increasing. In fact, on October 20th, 2022, the JPY hit 150, the lowest in over 20 years.
Given that Japan is the 5th largest importer globally and the US is the 2nd largest trading partner after China, lower JPY purchasing power will increase the costs of goods and services, de facto leading to an import of inflationary pressure.
Not helping is the fact that crude oil and gas top the list of imported goods which brings us back to the cost-push inflation. Combined with systematic monetary inflation, this is a challenging situation to solve.
Is there a way out?
There always is, but it won’t be straightforward because of fundamental challenges that cannot be easily overcome and certainly not overnight. One of the main structural issues is demographics.
Japan’s population of 125 million is declining and aging at the same time. Life expectancy is 85 and only second to Hong Kong.
By mid-century, the population is expected to shrink to 105 million. Of that, 38% will be over 65 years old and 15% under 20, leaving only 47% of the population in the working-age bracket.
Japan’s rapid population shrinkage is primarily caused by persistently low fertility, which has declined since the mid-70s. Young Japanese women have been increasingly reluctant to marry and have children, partly due to the rapid improvement of their economic opportunities that saw labour participation for women almost double, reaching around 90% today.
Not helping is the declining marriage rate, which can be attributed to the persistence of traditional domestic gender roles deeply rooted in Japanese society. In recognition of the challenge, the Japanese have introduced programmes and incentives to foster marriage, yet they still need to show significant improvements, and time is running out. I expect that this will be around for a while.
Appreciating that belief and value systems historically take time to adjust, and so do economic structures. Like many other developed nations, Japan has a concentrated power system with a bloated public sector that suffers from slow and inefficient resource allocations. Bureaucracy, excessive regulations, and protectionisms are strong indicators that scream for reforms.
The way forward
The combination of all these factors underlies the current socio-economic deadlock. It is necessary to undergo fundamental structural and societal changes to address the existential challenge.
The revival of the Japanese economy is important not only for Japan but also for Asian economies and the world.
The Japanese economy still enjoys a high-quality and diligent labour force supported by high education standards, indicating that the development base for growth remains sound and safe.
The digital economy offers a great opportunity for Japan to reinvent itself. Fintech, for example, is relatively underdeveloped and one way to reform the country’s financial services industry. As in any reform, you need a degree of belief, bravery, and grit to succeed. Change is possible, but it doesn’t just happen at the snip of a finger, quite the opposite.
I am fascinated by, and a great fan of Japan. Its culture and history are the most interesting and intriguing. The mix of tradition and modernity is unique in many ways. I observe my 9-year-old children feeling the same, from samurai warrior culture to manga books and anime movies.
There is a lot we can learn from Japan’s traditions, which as a Westerner living in Asia, I find has been lost in the “Old World”: Respect for the elderly, the importance of harmony both in private and business life, the appreciation of food and manners (arriving on time for example) are just a few examples I find worth mentioning.
Recognising the above, the team of weasia is actively pursuing establishing a presence in Japan, not only because it makes sense for our business case but also towards the Japanese economic revival.
Alberto is co-founder and CEO of weasia. Weasia is a fintech company that offers risk management and liquidity facilitation services to Indonesia's rural banks and its members. Weasia is a LaaS (Lending-as-a-Service) business bridging the gap between the international impact debt investor market and 135 million+ underserved community members, fostering financial inclusion and addressing the single most critical pain point for rural banks: Liquidity.