Japan and the race to the bottom

There are three tools of pro-capitalist macroeconomic policy: fiscal, monetary and currency.  There is total confusion among mainstream economic advisers on which of these policy tools is best to use to get capitalism out of its depression.  Monetarists like Ben Bernanke are wedded to cutting interest rates and ‘printing’ piles of money.  Keynesians want go further: they want to reverse neo-liberal fiscal austerity measures and let the government spending ‘multiplier’ work its magic.  And some, less vocal, advocate the benefits of devaluing the currency to boost exports.  Well, the newly elected Japanese government has gone for all three ‘solutions’ at once!

Japanese economic growth has been stalling. The government’s answer is to add yet more fiscal stimulus to the economy, to pump in yet more liquidity and now to drive down the value of the yen against the currencies of its major trading rivals.   That’s particularly important for Japanese capitalism, which relies on exports and investment for any marginal improvement in growth.  In just two months, the yen has depreciated by as much as 20% against the dollar from its peak.  This was necessary, in the minds of the Japanese, because the yen had been left behind in a ‘race to the bottom’ for the major currencies since the Great Recession began.   At one point, the yen had appreciated in real terms (taking into account relative inflation rates) against the currencies of its trading rivals by 30-40% since the Great Recession started.  Over the same period, the UK pound had dropped 25% and the euro by 10-15%.  Even the currencies of faster-growing emerging capitalist economies had not moved up.


Are these Japanese measures likely to work?  Keynesian guru, Paul Krugman, is doubtful (http://krugman.blogs.nytimes.com/2013/02/05/the-japan-story/).  For him, Japan’s problem is a monetary one, namely that Japan is in a classic Keynesian ‘liquidity trap’ where near zero interest rates do not restore investment or spending because ‘debt deflation’ is in operation.  What’s needed is a huge fiscal stimulus.  “Here’s my take. Japan has pretty much spent the past 20 years in a liquidity trap; as I’ve been explaining for years, one way to understand such traps is that they happen when, even at a zero real interest rate, the amount that people would want to save at full employment exceeds the amount they would be willing to invest, also at full employment…  What you need in this situation is a negative real interest rate — which means that you need some expected inflation, because nominal rates face the zero lower bound. ”

So the answer is more fiscal spending and monetisation to increase inflation deliberately.  Indeed, that’s what the US government should be doing as  well.  “Oh, and what about the US relevance? We are, for the time being, in the same situation. What I think you can argue is that because we don’t share Japan’s demographic challenge, our liquidity trap is probably temporary, the product of an episode of deleveraging. So in our case fiscal stimulus is much more likely to serve as a bridge to a revived era of normal macroeconomics. That said, I welcome efforts by the Fed to modestly raise inflation expectations, and would like to see more.  … it’s a tale of fiscal and monetary policy that have been too cautious, not of stimulus that failed.”   And it seems that outgoing chairman of the UK’s Financial Services Authority has also adopted a more Keynesian/Krugman turn, when he advocated in an FT interview that there were occasions (like now) when central banks should ‘monetise’ government debt by ‘printing money’ in order to boost an economy.

Interestingly, another Keynesian who would usually agree with Krugman seems to reject this explanation of Japan’s stagnation and Krugman/Adair solution.  Martin Wolf, the FT columnist, points out that Japan has had plenty of ‘fiscal stimulus’ over the years and it has done little to get Japan’s economy going (http://www.ft.com/cms/s/0/fd942ca0-6bc4-11e2-a17d-00144feab49a.html#axzz2K96zSyw).  And monetary stimulus and yen devaluation to cause inflation won’t work either because the problem is not deflation, as Krugman argues, “The persistent fiscal deficits and deflation are a puzzle. A standard explanation is that they are due to a mistake in monetary policy. If the central bank had avoided deflation, real interest rates could have been negative, making private investment and consumption stronger. I agree that this would have been helpful. But I disagree that deflation is the underlying cause of Japan’s ailment.”

So what’s the problem, according to Wolf.  Well it’s that Japanese industry is profitable but unwilling to invest.  “So what is that underlying cause? “Excess private savings” is the answer or, more precisely, a huge structural excess of corporate gross retained earnings over investment”.   There is some truth in Wolf’s view.   Over the last two decades, Japanese industry has not been investing nearly as much of its rising cash flow back into the real economy.  So the economy has struggled.


Japan’s capitalist sector, just as in other major capitalist economies, is not stepping up to the plate and investing in plant, equipment and employment to restore economic growth.  But the explanation for this also lies in the profitability of the Japanese corporate sector.  From 2002, Japan’s rate of profit rose 60% (blue line, left-hand scale below) while investment stayed pretty flat (red line, right-hand scale).  In the Great Recession,  profitability plunged and along with it, investment.  Profitability has now recovered, but it remains below the 2007 peak, so investment remains very much in the doldrums.


Wolf calls for these ‘excess savings’ (i.e. profits) to be taken away from the corporate  ‘oligopolies’ and used for the greater good: “the key to a better-balanced economy is taking the vast surplus profits away from a corporate oligopoly that has proved unable to use them. Corporate financial surpluses that end up in vast fiscal liabilities must be trimmed.  Let the public enjoy the income instead.”  How is this to be done?  Wolf proposes to raise corporate taxes, not cut them, shift profits into dividends for shareholders to spend and raise wages.  But these proposals would be anathema to the capitalist sector and will therefore fall on deaf ears.  And they would not work because profitability would fall back again.

Instead, the Japanese government is now looking to devalue its currency and inject inflation into the economy as a way of restoring growth.  This is very much in the tradition of the ‘beggar-thy-neighbour’ policies of the 1930s as it is of any Keynesian alternative.  The aim is to steal back world market share by making Japanese exports cheaper in world markets.  That’s why French prime minister Francois Hollande piped up yesterday to say that the Eurozone “must have an exchange-rate policy.  If not, it will be subject to an exchange rate that does not reflect the real state of the economy… we need to act on an international level to protect our own interests.” French capital is worried by the strength of the euro because French exporters are not performing as well in world export markets as German capital.  Thus, the response of Germany’s economy minister, Philipp Rostler was that the aim should be “strengthening competitiveness rather than weakening the currency”.

Historically, devaluation does not work for long as it leads to other governments adopting the same policy in a race to the bottom.    And there is little evidence that a weaker currency will help get better growth.  Look at the record of the last five years since the Great Recession.   The biggest depreciation in currency value since 2007 has been with the pound and the euro, but average real GDP growth has been negative over that period for them. The US dollar has appreciated and yet the US economy recorded a slightly positive growth rate in the period.  The yen appreciated dramatically, but Japan still had a better growth rate than the Eurozone or the UK.


What about in the period of global economic recovery since mid-2009?  Has devaluation helped?  All major economies have grown a little since the trough.  The US dollar has depreciated and growth has been over 2% a year.  But the euro has depreciated even more and growth has been less than half the US rate. The yen and the currencies of emerging economies have appreciated but real GDP growth has been passable.


Fiscal austerity has not worked; indeed, it has made the situation worse.  But neither has fiscal stimulus where it has been applied, as in Japan (I refer you to my post, The smugness multiplier for the evidence on that, https://thenextrecession.wordpress.com/2012/10/14/the-smugness-multiplier/).  The Keynesians say that it has not been applied hard enough and needs to be combined with a depreciation of the currency and even a boost to inflation with monetary injections.  In other words, try all three tools of capitalist economic policy at once.  That is what Japan is now doing.  We shall see if it succeeds.

15 thoughts on “Japan and the race to the bottom

  1. Another excelent piece. One small thing – you say Bernanke is a monetarist and thus favours printing money. But I thought the point of monetarism was to restrict the money supply – eg monetarism as was followed in the early Thatcher years. Isn’t printing money more a part of keynesianism?

    1. Philip
      Bernanke is a follower of Milton Friedman, the quantity of money man who reckoned that judicious use of monetary policy could avoid slumps. Bernanke once thanked Friedman for showing how the Federal Reserve would never be the cause of a major slump again, as it was in the 1930s according to Friedman and Bernanke.

    2. Philip:

      Monetarism as a theory holds that monetary policy is the best tool for economic management (because according to monetarists, fiscal spending is ultimately a drag on the economy). But we have to remember that any government policy is always applied to benefit the interests of the ruling classes. Central banks have always served the needs of finance capital above all other classes. In the 1980’s, this meant high interest rates and restricting the money supply to control inflation. In that era, banks still made their money from lending to households and businesses. Inflation was harmful to them (it benefits debtors and hurts creditors).

      But over time the financial sector grew exponentially and the majority of its profits came from investing in assets and instruments of debt. Loose monetary policy to encourage a fast velocity and circulation of capital was then in their interest. Thus in the 90’s and 00’s, interest rates remained low and the financial sector grew exponentially thanks to the growth of massive asset bubbles.

      1. Yep, I’m aware of all this. My point was that if the policy is to print a load more money, it’s not really monetarism. It’s more like a Keynesian policy. And, remember, the point I was responding to in Michael’s article wasn’t about the growth of the financial sector it was his comment specifically about *printing money*.

  2. Yet another desperate attempt by Japanese capitalists to breathe life into the economy. Can Japan kick the can down the road again after this attempt fails as well? Addicted to ever expanding credit and government spending Japanese capitals needed yet another fix. After 20 years you’d think that they would pull another rabbit. How long will this party last?
    I’ve been watching the Japanese ten year bond. It hasn’t really changed that much. Shouldn’t it have risen substantially? After all deflation will supposedly give way to inflation and yet another massive increase of the national debt. It seems to me that the ten year bond isn’t buying all of this.
    The more fictitious capital (credit) created will result in more of the surplus value getting diverted to paying interest. The ever expanding credit then becomes less and less effective but it’ll give rise to bubbles.
    Japan is a big exporter but it also has to import a lot of raw materials. The weak yen will make imports more expensive for Japanese capitals. Couple that with Japan’s high productivity it seems to me that the yen will eventually reverse course.
    But let’s go beyond observations in making the argument that currency devaluation doesn’t help in getting better growth. I was looking forward to a theoretical explanation. Is it safe to say that increased exports via the cheaper yen may result in enhanced mass of profits but it won’t help the rate of profit?
    Thank you.

    1. “I’ve been watching the Japanese ten year bond. It hasn’t really changed that much. Shouldn’t it have risen substantially? After all deflation will supposedly give way to inflation and yet another massive increase of the national debt. It seems to me that the ten year bond isn’t buying all of this.”

      Krugman discuses just this. See link below. Suffice to say that inflationary expectations are very much a reality in Japan right now.


      1. The government has been able to keep long bond yields so low because household savings have been used by the banks to buy bonds. So the demand for bonds has been sustained despite huge issuance. But household savings are hardly grwoing anymore and more corporate savings will not be sufficient compensation. And if inflation returns, then keeping cash on deposit will be loss-making. Then the government will find it more difficult to raise funds without bond yields rising. But that’s some time away, I suppose.

  3. Michael:

    “Historically, devaluation does not work for long as it leads to other governments adopting the same policy in a race to the bottom.” This may be a stupid question but why is that a bad thing? The Keynesians are arguing for inflation since it eats away debt (and the private and public sectors of the developed world are mired in debt). What if the central banks/governments of the US, EU, UK, and Japan all printed a bunch of money (relatively equal so that the exchange rates between them didn’t move), causing a large amount of inflation, thus eating away the public and private debts of all these countries? It seems though that this is what Keynesians ultimately believe: when the economy is bad, public spending is the answer, and the national debt isn’t a problem because it always can be inflated away. So it seems that in their world we should go on public debt binges followed by debt-erasing bouts of inflation.

    Am I incorrect in my assessment of the Keynesians? Regardless, I’m not sure of the economic reasons why these ideas wouldn’t work. My guess is that it would simply encourage the private sector to take advantage of the situation and try to rack up as much private debt as possible in the lead-up to the inflationary period, which would cause overheating and perhaps runaway inflation (if people knew a large amount of inflation was ahead, which seems to be the goal of Krugman’s suggested pollicies, albeit on a larger scale, the demand for cash would plummet, causing hyperinflation).

    Krugman actually seems to explicitly suggest this ‘everyone devalue’ idea here (besides his many posts that seem to suggest it):


    Another great post though and keep up the good work!

    1. High inflation devalues money. Therefore if I have £1000 savings and inflation rises, this £1000 can buy less stuff. Therefore in the current economic climate, it is just another version of austerity, only more general.

  4. Michael

    This is a nice piece but has some serious issues. It ignores the fact that the relationship between growth and currency is a 2-way street. For instance, Euro depreciation has been driven by worsening economic conditions and related captial movements. Similarly, emerging economy currencies are uniquely susceptible to flight to safety flows when local, or even global economy deteriorates. Mistake to associate association for causation!

    1. Vik

      that’s true. But as you say it works both ways. The recent rise in the euro is based on the belief that the issues you raise for its weakness in the past are abating. And the recent weakness in the pound is because the UK does not look so good any more. My main point is that devaluing an economy’s currency does not get an economy out of its mess, or only very briefly – indeed, as you say, its weakness merely expresses the weakness of the economy.

      1. Michael

        Agree that devaluation, or even printing money, itself is not enough to get an economy out of recession/depression. Again, important to note that printing money has key goals other than devaluation. For instance, Bernanke’s printing is meant more as a means to promote internal lending and asset appreciation in the face of imminent deflation.

        Export oriented economies, such as Japan, may try to focus more on the exchange rate aspects but increasing money supply is an important intervention, especially when the velocity of money slows down and/or when deflation is imminent. Devaluation merely impacts the trade balance picture but banks need to, and can, do much more for the economy.


  5. You quote Wolf as writing: “the key to a better-balanced economy is taking the vast surplus profits away from a corporate oligopoly that has proved unable to use them. Corporate financial surpluses that end up in vast fiscal liabilities must be trimmed. Let the public enjoy the income instead.”

    and then ask, “How is this to be done? Wolf proposes to raise corporate taxes, not cut them, shift profits into dividends for shareholders to spend and raise wages. But these proposals would be anathema to the capitalist sector and will therefore fall on deaf ears. And they would not work because profitability would fall back again.”

    I think Wolf is right about how to save capitalism. The capitalists have to give up control and ownership of some of the collective product of labour which is now sloshing around in their bank accounts. If the ‘capitalist sector’ won’t hear of it, they’re political fools. Well, maybe that’s to be expected.

    Profits would also be made from selling the commodities workers now unemployed would be producing once employed–workers who would also have corporate tax added to their incomes.

    Not that I’m out to save the wage system from its own out of date workings; but isn’t that what liberals and conservatives in positions of State power are supposed to be doing?

    As for the devaluation of the currency, the USD has been cut in half since I retired in 2000. Has this helped ‘the economy’?


    The devalued dollar has effectively cut Social Security payouts without political hassle for bourgeois politicians. It has also been a boon for U.S. exporters and foreign capitalists who are moving their means of production to the USA in order to achieve greater rates of exploitation of a devalued, wage-labour.

  6. Michael, in 1994 I did an honours paper on Japan and the World Economy and wrote a long essay (about 10,000 words) on Japanese economic take-off after WW2. If you’d like a read, contact me and I’ll email you a copy. At some stage I’ll get it up on the blog I’m involved in down here in NZ (Redline), but there’s one body of stats missing as I wait for a particular old issue of Far Eastern Economic Review to go electronic.

    You have a great blog, and we reprint a lot of your stuff.


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