Author Archives: wyna

School and Education Are Different Organisms

Back when I was a freshman here at  the University of Michigan, I wrote an essay for my English class regarding higher education. The title of the essay was “Why College?” and I discussed what education and college means in today’s society. As I am looking to finish my undergraduate years in Michigan, I would like to revisit some points as a farewell post. And of course, I won’t forget about relating it back to our economics analysis.

One of the main motives for me to write such an essay as a freshman  who had close to nil experience of at college was because from week 1, I felt a huge disparity between what the notion of education and college held for me. The summer before my first year, I took my passtime to read a little bit ahead of few courses that I was already determined to take. I eventually ended up reading the entire text book. Of course, I received no “credit” except maybe some self-pat-on-the-back and had to take the same course at school anyways in order for me to take more advanced classes. I felt like I was stuck somewhere between the reality of education system and my sincere desire to learn. Sadly enough there is really no proper way to resolve this problem. In the conclusion of my essay, however, I have stated that college is something more than just a place to earn credits.

Please do not mistake my point as downgrading the level of education and learnings you get from college. I do believe that college education is a vital part of your life whether it be in satisfying academic curiosity or prepping yourself to join the work force.  Education and learning are key values for anyone to evolve and pursue excellence. If someone asked me whether education is essential for success, I would most definitely say yes. However, if anyone asks me whether college is essential for success, my answer would be ‘it really depends.’ And my goal is to draw a dotted line distinction between the two.

The point of my essay and my personal anecdote is that we must look at college beyond its primary function. Of course when the first university and higher education institution was established, the biggest reason for people to attend was to learn and conduct academic research. Today, however, with the advent of information technology growth at its highest speed, there are plenty of opportunities for you to learn anything for (almost) free on the internet. The so called training you need for jobs could be done at home with a computer and a moderate-speed wifi connection.

Why then do students still come to college? One is for the community and network of people that you can flock together. It is a great chance to meet professors, future colleagues and business partners. Of course, how could I forget to mention that it is also a great marriage market. Another is because it is a social norm. As much as it sounds naive for me to say, many students are just there because their age groups simply go to college after high school.

I mention all this is because there is a price tag associated with school. According to WSJ article, student loans have become inefficient, as in, its return on human capital to society may be weaker than had anticipated. You can see many statistical metrics and data on education on the previous link, but to make the long story short, we must find a smarter way to finance education. Many students are heavily burdened with debt even before cashing in the first full-time paycheck. Setting the number calculations aside, it is discouraging to know that you will be in debt for the next decade or two even before you start.

There had been plenty of “is college worth the price” posts in the past few months here. I would like to reiterate that there are undeniable advantages of getting a college degree. The average income, lifespan, happiness index are higher for people with college degrees than those who do not. The fact that you are educated and are able to see the world with a keener and broader perspective is something you cannot measure. However, every person must carefully finance loans and consider their majors, future incomes and other life goals to truly get most bang for buck in college. I know this is not what all college students think about everyday, but it is something worth reminding themselves every now and then.

College and education institutions have evolved from a place where you could learn advanced academic knowledge into a place with enriching experience in  all aspects of your life. And education is simply one of them with slightly heavier weight than the others. Perhaps I was simply too young to see all this, and others knew how to enjoy college as is. In any case, I feel fortunate that I have realized all these point before I ended my college career.

I hope people found my self-epiphany somewhat useful if not at all useless.  I wish the best of luck to everyone in their future endeavors throughout and beyond college. Thank you!

(Revised) South Korea worries over interest rate.

In April 11, South Korea’s currency Korean Won (KRW) hit its record low exchange rate at 1,035 KRW per dollar, largest appreciation to reach the highest level since 2008. Although Korea’s economy is slowly gaining international recognition, but there are still obstacles for Korea to reach stability and still rag for higher growth.

According to South Korea Finance Minister Hyun Oh Seok, interest rate rise might pose great threat at home. South Korea have generally fared well despite 2008 financial crisis and Euro zone debt crisis. Just to see few data on inflation control and interest rate see charts:

Screen Shot 2014-04-12 at 12.22.54 PM Screen Shot 2014-04-12 at 12.43.25 PM

We see that there was a huge drop in nominal interest rate from above 5% down to 2%, and at the same time inflation dropped at about the same rate. As a result, the real interest had little influence. This abled Korea to control capital in/outflow and eventually the export quantity. Because it lacks natural resource endowments in its territory, Korea is quite dependent on its exports in order to buy necessary goods from foreign country. One characteristic of Korean exports is that it is focused on technological value added items . To name a few, cell phones, TV’s, naval engineering goods and automobiles are some of more known items.

As a result, in order for South Korea to be really stay on its competitive edge requires favorable financial conditions, especially those regarding exchange rates and interest rates. So, what happened to Korea in the past few months? There has been a huge appreciation in KRW and some economists in Korea worry that this will be a head wind against its growth in coming years.

Screen Shot 2014-04-12 at 12.52.23 PM

Another big concern for Korea right now is climbing household debt level reaching its record high (see graph below) at a wrong time. The Fed is continuing to taper quantitative easing programs, and the talk of whether interest rate will increase sooner than anticipated will also play a role in markets other than that of US. Why Korea should really be worried is that most of household debt is tied to mortgage in floating interest rate. Not to mentioned the housing prices rising due to cultural flux of real estate as a popular investment options, the trend of borrowing to finance these houses drive the prices up. Consequently, if interest rate hike around the world raises interest rates in Korea, burden on household could cause a series of default, which would in turn drive down the housing prices as well.

Screen Shot 2014-04-12 at 12.39.39 PM

High debt level and high interest rate are something that Korea is not so fond of with harsh memory of defaulting less than two decades ago. There has been government measures to mitigate mortgage loan by directly bailing out some of highly distressed households, but this has not been so popular for many people on the ground of moral hazard. Also, such high spending is a good vulnerable points for either political parties. Although current level of debt is of course not as bad as the level during the Asian financial crisis in 1996, but it is something to keep in mind over time. Considering that it is the large bandwidth of middle class in Korea that holds mortgage debt, this could arise as a serious problem.

Screen Shot 2014-04-19 at 3.05.25 PM (Source: here)

Another thing I would like to point out briefly is the trends of disinflation, and elongated times of inflation rate. With target band between 2.5% and 3.5%, the 1.3% Korea has right now may be not so satisfying. With inflation rate going down, monetary policy instrument may be eroding its power, at least less than it could fully have. I don’t think it is at a worrisome level just yet at nominal interest rate still at 2.5%, but this is another sensitive spot for Korea.

Although Korea is number four economy in its geographical region of East Asia, it should be still considered as a “small economy.” Yes, it experienced very high growth and despite hardships in the past had came out of its crises at a record speed, the economy is still very vulnerable to financial market around the world. After having such a bitter experience in 1996, Korea’s financial market is one of the most heavily regulated market in East Asia. I personally think in order for Korea to truly grow, it should allow financial sector to grow as a stronghold for the entire economy to fare well.

Inflation Rises and Eases Fed’s Worries

The new data on inflation suggests that there has been an increase in inflation rate from 1.1% to 1.5%, easing worries of the Fed for the low inflation rate. As I have repeatedly wrote in the past posts about US recovery and surfacing evidences that might suggest this, I would like to touch base again on stock market, housing price, employment, US financial climate and worldly financial climate.

First and foremost, I want to reiterate that this should be a great relief for the Fed. Taking away the food and energy bundle from CPI, the core inflation rate is actually higher at 1.7% only three basis points away from the inflation target of 2.0%. Just two months ago, chairwoman Yellen was worried that inflation rate was too low at 1.1%. However, the current situation will give the Fed more room to play with easy money supply and (real) interest rate. Continuing from previous worries over early interest rate increase among investor also can be mitigated a little bit. The unemployment rate still has not changed from 6.7%.

Screen Shot 2014-04-16 at 10.40.47 AM (source: here)

As chairwoman Yellen stated last month that interest rate increase will be on schedule with incumbent plan in place, this is a good news for most investors.

A WSJ article suggests that this increase in inflation is largely due to housing and food price rise. However, I have some doubts in this article. First of all, the food prices are very volatile anyways, so what we should be looking at is the core inflation rate. In regards to the housing market, yes, the homebuilders have beat the market expectation, but if the trend of expectation was very low in the first place, they do not have to much influence in the market. The article I found suggests the following:

U.S. housing starts rose 2.8% in March to a seasonally adjusted annual pace of 946,000, fueled by growth in single-family homes, the Commerce Department said Wednesday. Starts for February were revised higher, showing a slight gain that month instead of the initially reported decline.

But other figures indicated the recovery remains dicey despite the onset of spring. Compared with a year earlier, housing starts were down 5.9% in March. And building permits, a bellwether of future construction, declined 2.4% in March from the prior month to a pace of 990,000, marking the fourth drop in five months.

Therefore, I think it is still early to predict that the recent turnaround in the housing market can be a positive sign for long term stability.

In terms of stock market, the market has been faring very well in the past 5 years or so. Ant the Pesky Indicator says US stocks are still undervalued, leaving room for more appreciation in value in the future. For more macro US stock market analysis, please refer to my recent blog here. In short, the market has been faring well since the great recession, and even at 10 year level of macro investing, it would have given you close to 5% return–much higher level you expect from safe bonds and other savings.

At international level, I want to talk specifically about China. Although their GDP growth is at 6th quarter low at 7.4%, that is still a very big number. Also this number is still beating most analysts’ and economists’ expectation. We know from rule of 70 that in less than 10 years China would double the size of their economy. There also has been a recent regulation cut down from Chinese government that rural banks’ reserve requirement would be lower. This would work as easy money for Chinese and many investment projects can be financed more easily.

Overall, I would like to restated–as I have repeatedly done so in my past posts– US economy is on a recovery track. A very good one too. Thusly, I am pretty optimistic about the market for the next 2 and a half quarter to about a year or so.

How long will the bull market continue?

Today, a wsj article said that we are approaching 7th inning in our bull market before the level out. As we learn of the efficient market theory and other assumptions that many economists use like rational expectation, I would like to show what the stock market has fared recently in relation to the theories mentioned above. Also at the end, I would like to add my thoughts looking forward as there has been many factors that influenced the stock market in past few months.

So, how have we fared in the lens of long term? Ever since the end of recession in 2009, the stock market had performed fantastically. Just to look at few indices, the S&P 500 showed 113% increase and the Dow Jones showed 101% increase in value over the past five years (see graph below). That is about 16.40% and 14.74% compounded annualized return, respectively.

Screen Shot 2014-04-14 at 8.44.18 PM Screen Shot 2014-04-14 at 8.46.25 PM

Well, what are some of the factors that carried this high growth rate in the market? First of all, as I and numerous others have pointed out, the easy money policy or the quantitative easing, coupled with zero lower bound interest rate had a significant effect in the economy. Also, a large sum of money that was used in fiscal policy financed many investments and purchases of assets kept the economy from completely falling. Despite the down trodden conditions after 2008, fiscal and monetary policy supporting the economy had put us back on track on recovery. It is true that there are much debates about whether the magnitude and degree of recovery track we are on is enough, but what we all agree on is that we are coming back.

How does this tie back into the rational expectation and efficient market theory? What investors were most interested in during the past 5 years was to see what the federal reserve was going to do. To put myself into an investor’s perspective, the quantitative easing and the zero lower bound would mean it is very cheap to do many kinds of investment activities. Therefore, firms in the US might take this opportunity to carry out some projects they had in mind previously. Now if we can blow this up into macro perspective, many firms would be spending money as necessary and the spending of many firms would fuel the economy.

Another twist to this account is that even though this may seem like zero lower bound and easy money would surge the inflation rate, the interest rate that banks receive from the Fed simply by putting them in the vault had risen to a positive number. In other words, financial institutions were lending only those money that are deemed viable. This decreased the velocity of the money all the while having much of necessary investments being financed.

Knowing these information as an investor, people who handle money would have allocated money right back into the stock market–or at least keep it there–after the announcements from the Fed. This, according to the efficient markets theory and rational expectation in force, would have corrected the stock prices immediately so that people only benefit the “normal” return.

But, we see that this is not the case in many accounts as investors. Anyone who went into the market in 2009 was deemed as a contrarian and was considered very bold. We see that the two indices enjoyed 16% and 14% annualized return which compared to 10 year annualized return of around 4% for each indices if they had kept the money. We know as humans it is hard to keep our animal spirits inside us and be cool headed in times of recessions or extraordinary booms.

I personally agree with what the author of the article in the beginning said. The bull and bear can only last for so long. The bull we see today is only the ramifications of the trough we saw 5 years ago. So, if you do not have the guts to be a contrarian–not many people do and you can still make a good sum of money without being one– I suggest like the random walk theory or the efficient market theory suggest, invest in indices and keep your head cool.

South Korea worries over interest rate hike

Following from a recent news about South Korea’s exchange rate and its record high appreciation since 2008, I want to talk about the general threat that Korea may face in the near future.

According to South Korea Finance Minister Hyun Oh Seok, interest rate rise might pose great threat at home. South Korea have generally fared well despite 2008 financial crisis and Euro zone debt crisis. Just to see few data on inflation control and interest rate;

Screen Shot 2014-04-12 at 12.22.54 PM Screen Shot 2014-04-12 at 12.43.25 PM

We see that there was a huge drop in nominal interest rate from above 5% down to 2%, and at the same time inflation dropped at about the same rate. As a result, the real interest had little influence. This abled Korea to control capital in/outflow and thusly export. Because of lack of much natural resource endowments, Korea is quite dependent on its exports. one of the characteristics that Korean economy shows is that many exports are highly value added items with high technology. To name a few, cell phones, TV’s, naval engineering goods and automobiles.

As a result, in order for South Korea to be really stay on its competitive edge requires favorable financial conditions, especially those regarding exchange rates and interest rates. So, what happened to Korea in the past few months? There has been a huge appreciation in Korean currency Won and many worry that this will be a head wind against its growth.

Screen Shot 2014-04-12 at 12.52.23 PM

 

Another big concern for Korea right now is climbing household debt level reaching its record high (see graph below) at a wrong time. The Fed is continuing to taper quantitative easing programs, and the talk of whether interest rate will increase sooner than anticipated will also play a role in markets other than that of US. Why Korea should really be worried is that most of household debt is tied to mortgage in floating interest rate. Consequently, if interest rate hike around the world could bring back up the interest rate in Korea, burden on household could cause a series of default.

High debt level and high interest rate are something that Korea is not so fond of with harsh memory of defaulting less than two decades ago. There has been government measures to mitigate mortgage loan by directly bailing out some of highly distressed households, but this has not been so popular for many people on the ground of moral hazard. These kind of approach is also very costly in political games.  Although current level of debt is of course not as bad as the level during the Asian financial crisis in 1996, but it is something to keep in mind over time.

Screen Shot 2014-04-12 at 12.39.39 PM

Another thing I would like to point out briefly is the recent low level of inflation. With target band between 2.5% and 3.5%, the 1.3% Korea has right now may be not so satisfying. Yes, Korea have endured quite well the recent financial crises around the world, but with inflation rate going down, monetary policy instrument may be eroding its power, at least less than it could fully have. I don’t think it is at a worrisome level just yet at nominal interest rate still at 2.5%, but this is another side that Korea should really keep in mind for the next few years.

Although Korea is number four economy in its geographical region of East Asia, it should be still considered as a “small economy.” Yes, it experienced very high growth and despite hardships in the past had came out of its crises at a record speed, the economy is still very vulnerable to financial market around the world. After having such a bitter experience in 1996, Korea’s financial market is one of the most heavily regulated market in East Asia. However, I think in order for Korea to truly grow, it should allow financial sector to grow organically.

 

(Revised) The point of fiscal policy

Since the founding of the country or even perhaps way beyond the time horizon,one of the quintessential controversy of a state was how the government should handle citizens’ money. This has been just as much a dilemma for political scientists and philosophers as it is for economists. Even in states without a democratic institutions, it is still a big problem for monarchs, oligarchs and alike to decide where and how to spend the budget on hand. In today’s term for many countries, it is the debate of budget deficit, whether we should allow it or not, and if we do, by how much should we allow it.

For anyone who supports laissez faire, which literally means ‘let them do’ in French, signifying minimum government intervention in the economy, should really hate the advocates of ‘austerity’ and ‘growth.’ For the former, austerity supporters want near-perfect balanced budget, requiring government to tax a huge sums to reduce the budget gap. For the latter group, growth supporters are focused on short-term expansion of GDP growth, and want the government to spend over the budget.

According to a wsj article by Dan Mitchell, the two groups are missing the point. As Milton Friedman had said, the concern shouldn’t be deficit or no deficit, but the size of the government. Mitchell claims that the ‘golden fiscal rule’ is to have the government spending grow at a slower rate than the growth of private economic sector. This sounds quite intuitive. If the government can manage slower expansion in spending than the growth of private sector, the government should have enough taxes under relatively smaller government spending. Even in the times of bad supply shock, the economy can be more stable since it has room for more effective fiscal stimulus without burdening the tax payers too much. In other aspects, the article says the following:

A golden rule has several advantages over fiscal proposals based on balanced budgets, deficits or debt control. First, it correctly focuses on the underlying problem of excessive government rather than the symptom of red ink. Second, lawmakers have the power to control the growth of government spending. Deficit targets and balanced-budget requirements put lawmakers at the mercy of economic fluctuations that can cause large and unpredictable swings in tax revenue. Third, spending can still grow by 2% even during a downturn, making the proposal more politically sustainable.

Although the focus here is economic growth and stability, I want to point out first the sustainable political atmosphere that is created through this strategy. Monetary policy and fiscal policies are often dampened in their magnitude due to political conflicts. Professor Kimball claimed that Obama’s failure is not being able to spend more (despite the congressional shutdown and the long talk of dangerous fiscal cliff), not spending too much.

From the vantage point of economics, I think this could be a strategy that could end many of the debates that are being discussed right now.  Government spending growing at a slower rate than private economy will ensure downsizing of the government–closest we can get to achieving laissez faire fantasy. And this is not an unproven virgin theory, but bears a lot of success stories where governments achieved balanced budget and still had high growth rate. To name a few:

Ireland (1985-89), Slovakia (2000-04), Singapore (1998-08), Italy (1996-2000), Lithuania (2008-present), Taiwan (2001-06), Israel (2002-05), Estonia (2008-11), Iceland (2008-present), and the Netherlands (1995-2000)

These countries all have enjoyed high nominal gdp growth while restoring budget balance. Currently, Congressman Kevin Brady is proposing a similar budget planning strategy for the US. I hope he can weave something that works for this country.

The point of fiscal policy

Since the founding of the country or even perhaps way beyond the time horizon, one of the roots of conflicts was how government is going to use its citizens’ money. Even in institutions without democratic state, it is still a big problem for monarchs, oligarchs and alike to decide where and how to spend money. In today’s term, it is the debate of budget deficit, whether we should allow it or not, or if we do, by how much.

For anyone who supports laissez faire approach of the government should really hate the advocates of ‘austerity’ and ‘growth.’ As for the former, austerity supporters want near perfectly balanced budget, requiring government to tax a huge lump sum and reducing the budget gap. For the latter group, growth supporters are focused on short-term expansion of GDP growth, and want the government to spend over the budget.

According to a wsj article, the two groups are missing the point. As Milton Friedman had said, the concern shouldn’t be deficit or no deficit, but the size of the government. It claims that the ‘golden fiscal rule’ is to have government spending grow at a slower rate than the growth of private economic sector. This sounds quite intuitive. If the government can manage slower expansion in spending than the growth of private sector, the government budget deficit is going to be very manageable. Even in the times of bad supply shock, the economy can be more stable since it has room for more effective fiscal stimulus without burdening the tax payers too much. In other aspects, the article says the following:

A golden rule has several advantages over fiscal proposals based on balanced budgets, deficits or debt control. First, it correctly focuses on the underlying problem of excessive government rather than the symptom of red ink. Second, lawmakers have the power to control the growth of government spending. Deficit targets and balanced-budget requirements put lawmakers at the mercy of economic fluctuations that can cause large and unpredictable swings in tax revenue. Third, spending can still grow by 2% even during a downturn, making the proposal more politically sustainable.

Although the focus here is economic growth and stability, I want to point out first the sustainable political atmosphere that is created through this strategy. Monetary policy and fiscal policies are often dampened in their magnitude due to political conflicts. Professor Kimball claimed that Obama’s failure is not being able to spend more (despite the congressional shutdown and the talk of fiscal cliff), not spending too much.

From the vantage point of economics, I think this could be a strategy that could end many of the debates that are being discussed right now.  Government spending growing at a slower rate than private economy will ensure downsizing of the government–closest we can get to achieving laissez faire fantasy. And this is not an unproven virgin theory, but bears a lot of success stories where governments achieved balanced budget and still had high growth rate. To name a few:

Ireland (1985-89), Slovakia (2000-04), Singapore (1998-08), Italy (1996-2000), Lithuania (2008-present), Taiwan (2001-06), Israel (2002-05), Estonia (2008-11), Iceland (2008-present), and the Netherlands (1995-2000)

Currently, Congressman Kevin Brady is proposing similar budget planning strategy for the US. I hope he can weave something that works for this country.

20 Years of NAFTA- Mexico and US relationship

2014 marks the 20th anniversary of the North American Free Trade Agreement (NAFTA). There were many hardships not simply in writing of terms of trade, but also there were political conflicts in all three conflicts.  Today, I want to see how three countries have fared so far.

If you had taken Econ 101, one of the first things that students learn is comparative advantage and how trade can increase utility and benefit all parties. The gains will almost always outweigh the loss. Knowing this, it may sound like it is a no brainer decision for all countries to engage in free trade. In reality, there are imperfect political systems and other industry specific factions might lobby for/against FTA’s.

One of the biggest issues that the democrats in US had feared going into FTA was loss of jobs in the US soil due to cheaper labor cost in Mexico. If the tariffs are lowered and other barriers for trade is lowered, US manufacturing firms would move to Mexico and take advantage of the labor force there–and this makes perfect sense. We have to remember that there are losers from trade in the short run. Also, the whole notion of redistribution is not as easy as it sounds from the economics textbook models. There are numerous legal, budgetary and even ethical hurdles that the government must overcome to guarantee that the gains from trade is gains for everyone.

According to a wsj article here, these worries can be ignored in many aspects. To lay out a few:

  • Unemployment rate did not increase, but decreased instead;
  • Tariff and non-tariff trade barriers were lowered;
  • Industry integration between three countries strengthened;
  • volume and net worth of trade goods steadily increased; and
  • All three countries experienced wage growth.

I think all these points are still very valid, but there are some possible watering down of the real effect after closer examination.

Contrary to what many people feared, the FTA brought about increase in employment. Compared to the pre-FTA periods of unemployment at 7.1%, 1994-2007 in the period of NAFTA, US enjoyed average unemployment rate of 5.1%. This is largely good news, because Mexico did not take away our employment, but I think it is hard to caliber how much of this improvement is actually from NAFTA, but not something else?

The notion of tariffs and other trade barrier could be a little controversial. Yes, the tariffs were lowered, but legal regulations were strengthened in some sense. According to a Bloomberg article here, yes, Mexico surpassed Japan in US auto exports, but if you look at closely, you will find out that it is the heavy FDI from Japanese auto companies that allowed their foothold in Mexico and sell it directly from there to US.

In re: of wages, although their real wages all increased, the disparity between US and Mexico did not improve as much as experts had anticipated. Some say this is largely due to large volume of unskilled laborer immigrants to US that is keeping this disparity.

I think overall the NAFTA is doing a terrific job. It helped revive Mexico after its default in 1994 for sure. The Canadians, although I have not mentioned much on this post is doing well with ever more increasing trade volumes in all borders between the two countries. Anticipated worries proved to be wrong, and all three countries are enjoying the benefits from free trade. I think US should also do a careful job in weaving an agreement for Trans-Pacific Partnership to expect good overall benefits like that of NAFTA.

 

(Revised) New Chapter in Abenomics

For today’s discussion, I would like to a little bit about what some next steps the Japan had taken for its famous Abenomics. Japanese government increased the sales-tax from 5% to 8% today. There is no surprise here since this was part of Abenomics plan announcement well back in 2012. But, I do want to do a half-time check on how Japan is doing with its plans and see whether it really had a significant effects in dimensions of economics.

It is hard to talk about Japanese economy without discussing what we call the lost decade–which had continued to reach two decades soon. I already have a blog post on the lost decade, so please go here for more details. Anyhow, the short version is that after 1990’s real estate bubble, Japan has seen very low inflation rates or even deflation–staggering growth and sometimes contracting up until recent years.

The biggest problem with low inflation is that the economy becomes highly vulnerable to exogenous supply shocks. The central bank also loses control over its monetary policy instruments. Even with the lowest interest rate of 0% since way back, negative inflation will bring real interest rate to positive side, resulting in net capital inflow and loss in net export. Just a glimpse on the graph below shows very high volatility in inflation at the lower end.

Screen Shot 2014-03-31 at 6.07.00 PM (Source)

To make up for the big loss in exports and domestic private investments, the government had to spend a lot–and by that I mean A LOT (see graph below).

Screen Shot 2014-03-31 at 6.11.31 PM

The debt-to-gdp ratio was at about 67% and now the owe more than twice of their income. One of the things that Japanese government did when they faced the real estate bubble deflating was to spend a lot. How did this work out for Japanese?

In terms of today’s goals, this is part of Abenomics’ goal. Although they are still heavily indebted, they wanted to do the extra mega-spending in fiscal policy and even looser monetary policy in order to override the deflation they were experiencing.  The fiscal burden as you can see have been growing at a very fast pace. Japan also used very loose monetary policy, weakened the yen and made it stay there to restore some balance in the trades.

I want to give Abenomics some credit in restoring its economy. Although it went down 9% this year thus far, the Nikkei rose 57% last year. Also, it is on its way to reach the inflation target of 2% (now at 1.3%). On the other side, I think Japan is playing it very close to the line with continuing rise of the debt. Yes, they decided to raise the consumption sales-tax to 8%, but the condition for continued high confidence level is still very unpredictable. There has to be more of tax raise and other spending cuts in order to deal with the debt in the coming years, but it is still unclear whether the net effect of Abenomics would be positive.

Some pessimists like Gordon Chang is appalled by Japan’s approach and think Japan is undoubtedly going to default, causing massive financial crisis around the world. Other countries that are in international trade competition with Japan–countries like EU, South Korea, etc.–complain that it is very unjust for them to play the beggar-thy-neighbor approach.

I personally think that what Abe’s government did has no moral culpability per se. Ignoring the fact that Japan is still number 3 in terms of total nominal GDP, I think they used their last bullet in the gun to shoot for a comeback to their heydays growth level. They are running out of fiscal policy options with enough deficits in hand already. Monetary policy had been inoperative for many years and even more so now perhaps. To me it seems like Abenomics took the eat-a-lot-now-and-fast-later approach, and hopes that what they had eaten will last long after their fasting period. As Japan just begins their fasting period, they can only hope that their momentum will last

Japanese consumption-tax rate increase

Today, I would like to a little bit about what some next steps the Japan had taken for its famous Abenomics. Today, Japanese government increased the sales-tax from 5% to 8%. There is no surprise here since this was part of Abenomics plan announcement well back in 2012. But, I want to do a half-time check on how Japan is doing with its plan and see whether it really had a significant effects in many dimensions of economics.

It is hard to talk about Japanese economy without what we call the lost decade–which had continued to reach two decades soon. I already have a blog post on the lost decade, so please go here for more details. Anyhow, the short version is that after 1990’s real estate bubble, Japan has seen very low inflation rates or even deflation–staggering growth and sometimes contracting up until recent years.

The biggest problem with low inflation is that the economy becomes highly vulnerable to any supply shocks. The central bank also loses control over its monetary policy tool. Even with the lowest interest rate of 0%, negative inflation will bring real interest rate to positive side, resulting in net capital inflow and loss in net export. Just a glimpse on the graph below shows very high volatility in inflation.

Screen Shot 2014-03-31 at 6.07.00 PM (Source)

To make up for the big loss in exports and domestic private investments, the government had to spend a lot–and I mean A LOT (see graph below).

Screen Shot 2014-03-31 at 6.11.31 PM

 

The debt-to-gdp ratio was at about 67% and now the owe more than twice of their income.

To be fair, this was part of Abenomics’ goal. In order to raise consumption and investment momentum it had lost two decades ago, Japanese government spent enormous amount in fiscal spending . Japan also used very loose monetary policy, weakened the yen and made it stay there to restore some balance in the trades.

I want to give Abenomics some credit in restoring its economy. Although it went down 9% this year thus far, the Nikkei rose 57% last year. Also, it is on its way to reach the inflation target of 2% (now at 1.3%). On the other side, I think Japan is playing it very close to the line with continuing rise of the debt. Yes, they decided to raise the consumption sales-tax to 8%, but the condition for continued high confidence level of Japan is I think still very unpredictable.

Some pessimists like Gordon Chang is appalled by Japan’s approach and think Japan is undoubtedly going to default, causing massive financial crisis around the world. Other countries that has trading competition with Japan, countries like EU, South Korea, etc. complain that it is very unjust for them to play the beggar thy neighbor measures.

I personally think that what Abe’s government did has no moral culpability. Ignoring the fact that Japan is still number 3 in terms of total nominal GDP, I think they used their last bullet in the gun to comeback to their heydays growth level. They ran out of fiscal instruments for a very high debt level. Monetary policy had been inoperative for many years and now even more so perhaps. Abenomics took the eat-a-lot-now-and-fast-later approach. As we are coming into the fasting part, Japanese should hope that their momentum while they were eating will not lose out.