Japan; from quagmire to Abenomics to collapse! Part I

Part I: Toward the abyss

Japan has been in a stable, but unsustainable, equilibrium for years. Its leaders know it is unsustainable and in their immense wisdom, decided to manage the whole system in order to achieve a sustainable development. However, this will prove fraught with danger since moving an unsustainable system away from its steady-state runs the risk of unleashing a gale wave of unintended consequences. The problem of course is that the people now in charge of moving the Japanese system from its current constellation have absolutely no idea on how to get it from where it is back on sound footing. The reason is simple, as with most policy quacks they are taught by other quacks. Some of the teachers even have Ph.D.’s. in quackery to prove to lesser quacks who truly master the art of quacking; we call them economists.

Economists are a group of people that look upon the social structure called the economy with condescension and arrogance. They see it as their task to manipulate other people in order to build confidence. If confidence is high, then economic growth, prosperity and bliss will come automatically. The problem is that when people feel down they do not spend money. And when people do not spend money, economic growth turns into contraction and people feel even worse in what turns out to be a self-reinforcing cycle of less growth, less confidence and even less growth and so on in perpetuity.

This is basically how Prime Minister Abe and his newly installed lackeys at the Bank of Japan see as the situation in Japan today. In the early 1990s people lost confidence for some unexplained reason, and because the supposedly omniscient masters did not do enough manipulation back then, confidence was never regained; which essentially explains the predicament Japan is in now.

The real reason is more fundamental though and we will explain what happened in Japan. Before we do so, it is of the utmost importance for the reader to know what gross domestic production, or gross domestic consumption (GDC) as we call it, really is. It is essentially the amount of money spent on goods and services over a specified period of time. In other, and more “technical terms”, we can say that GDC is comprised of the monetary base * leverage in the fractional reserve banking system * money circulation.

The central bank manufactures monetary base at its own discretion. However, the broader money supply is dependent on a solvent banking system. If banks under the jurisdiction of the central bank are insolvent they cannot increase their balance sheet, or leverage up on the base money. After a financial crisis it is therefore hard for the central bank to create inflation since legacy assets held by the banks will weigh on their ability to create additional demand deposits. In addition, as banks hold back on money creation, transactions will inevitably drop. As you can see, it is actually true that an activist monetary policy can create growth in gross domestic production, but only because the very concept measures inflation of broad money supply and nothing else. From this follows a surprisingly well hidden fact; the debt to GDC ratio is important onlybecause it measures whether debt is created at a rate faster or slower than monetary inflation. This is why it has become so important for the new Japanese administration to create nominal GDC growth. They are desperate to inflate away the big pile of debt they have accumulated of which there is zero chance of ever being repaid. Put bluntly, they want to default covertly through inflationary resource confiscation.

If we look at the monetary breakdown of Japanese GDC we see a negative velocity effect. That means only a fraction of existing money circulates during the period of measurement (one year). However, by raising it to something greater than one –ceterius paribus – Japan could lift its GDC from the current level of Yen500tr to Yen800tr and simultaneously reduce the debt ratio from 230 per cent to 140 per cent! Alternatively, they could double the monetary base and again – ceterius paribus – reduce the debt ratio to around 100 per cent.

Please note that none of this creates any value at all, but only help to redistribute realwealth to the government which can squander it as the ruling class see fit.

Source: Bank of Japan (BoJ), Cabinet Office (CAO), own calculations

The second thing the reader needs to know about economics is that debt can have a positive or a negative effect on wealth creation, depending on what kind of deb. If the debt is made with the intent of making a subsequent sale, id est. a business loan, it will help increase capital accumulation. However, if the debt is taken on to fund current consumption it will decumulate the capital stock and make society poorer. In our work, we usually divide between good, bad and destructive debt. Good debt consists of business loans. Bad debt is defined as household and financial sector loans while government debt fit right into our category called destructive debt. Basically, debt need to have an intrinsic yield high enough to pay back the resources it helped claim from society, plus interest, for it to be considered good. Note, debt that is dependent on others yield or production, such as taxpayers, is not self-sufficient and cannot create prosperity. With this in mind we look at what happened to Japan before and after it crashed in the 1990s

Source: Bank of Japan – Flow of Funds (BoJ), own calculations

Japan in the 1980s and 1990s show a remarkable resemblance to the US during the 2000s. In the midst of bubble finance, the system funded bad debt in droves. This pulled capital out of the system without replenishing it. Conventional wisdom tells you that the 1980s was a decade of spectacular growth for Japan, but truth be told they actually got a lot poorer by consuming capital. When the Bank of Japan (BoJ) felt compelled to raise interest rates sharply from 1989 to 1990 the malinvestments could no longer be funded. The bust was inevitable.

When the bubble finally burst as a consequence of the misaligned capital structure, the government stepped in and bailed out the bad debt by adding destructive debt. Of course, this policy benefitted the corporative part of the economy, such as big banks and politically connected businesses, but at the expense of zombifying the economy. Bad investments continued to drain the system of scarce capital, while the government doubled down in a desperate attempt to kick-start money multipliers and velocity.

But money multipliers could not be expanded because the banking system was rendered unable to increase base money leverage since they continued to fund capital projects that bled the economy dry.

In a desperate attempt to rectify the lack of “private sector” initiative the Japanese leaders schooled in Keynesian multipliers knew that their wasteful spending would at one point fund itself through higher tax income. Now, that did not work out as they hoped as spending soared while income kept falling.

Source: Ministry of Finance (MoF), own calculations and projections

Note that bond issuance has been larger than tax revenues since 2009 and under very conservative assumption will continue to be so for the foreseeable future. Japan has ended up in a rather peculiar situation in which revenue abide by the” laws” of deflation while spending reflects that of a system in inflation.


In an attempt to bail out unsound investments, Japan cemented an economic structure that was unsustainable. This lead directly to persistent capital consumption and a “lost decade(s)”

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