Japan, the world’s third largest economy, is next on the list of countries on the verge of financial ruin.
Since the early 2000s, Japan has accumulated vast amounts of debt with one of the highest GDP ratios in the world. Today, the average monetary exchange rate between Japan and the U.S. is 100 yen to one dollar.
Recently, Japan has attempted to shock its economy out of slow economic growth and deflation by implementing aggressive stimulus plans. In a process known as quantitative easing (QE), a central government bank creates money, which it then uses to increase the money supply by purchasing financial assets.
It’s this Keynesian approach to economic decline that Japan will use in the hopes of sending its economy on the road to recovery.
Japan’s Prime Minister Shinzo Abe, who recently took office, called for a “rocket-like start towards economic recovery.” He has appointed Haruhiko Kuroda, the new president of the Bank of Japan, who backs his approach.
Through the devaluation of the yen, Abe wishes to step away from deflation and shift towards his goal of two percent annual inflation. His aim is to boost economic growth by encouraging spending.
His idea is simple: if you know prices will increase in the near future, you will be more likely to spend now rather than wait. In theory, it is an easy way to promote consumption and investment.
Abe has promised to put an end to wasteful spending and claims he intends to focus economic investment in three areas.
The first is the region that was affected in March 2011 by the tsunami. The second is making improvements to the country’s aging infrastructure, which claimed the lives of nine Japanese citizens in a fatal tunnel crash last December. Thirdly, Prime Minister Abe wants to quakeproof schools and hospitals.
Abe and Kuroda can’t miraculously make Japan’s corporate giants more competitive on the world stage, such as making Sony competitive with Samsung in the smart phone market or Toyota making significantly better cars that Hyundai. Still, these Japanese policies to devalue the yen could give those companies an advantage in the global marketplace in terms of their cost structure.
Christine LaGarde, managing director of the International Monetary Fund, recently defended Japan’s political actions. She stated to CNBC, “They’re doing what they can to kick-start growth when there has been none for a long time, and to make sure that credit flows into the real economy so that investment can start again.”
Japan is an example of what the U.S., as well as the rest of the developed world, could become if they do not move out of a long period of economic stagnation.
Many developed countries are struggling with similar issues such as their public debt and the increase of welfare cost due to their aging population.
In many forms, Japan can be seen as a test case for many countries. With a similarly aging population, Japan’s economic model will become a model for success, or a cautionary tale.