In the context of the current economic malaise, one of the clichés that often gets thrown out there is that the U.S. will turn into Japan – that is, suffer multiple lost decades because of a liquidity trap that monetary policy alone cannot help the economy escape from.
Hogwash.
Japan is a highly homogenized and xenophobic culture with meaningful individual savings. Why does it matter? Well, as compared to the U.S., Japan has been able to fund itself largely through the citizenry. As a consequence, despite various efforts in the past where the government has tried to implement fiscal stimulus, the BOJ has always eventually taken steps to mitigate the impact (Scott Sumner has written several posts over the years speaking to this reality; see here and here). In part, because of a concern for those institutions and the old Japanese folks that own bonds and/or live off of fixed incomes, the BOJ stands ready to dampen fiscal policy at the first whiff of inflation. Accordingly, the expectations shift that might normally come with government largesse is weakened.
Now, contrast that with the U.S., where the fear is deflation. And, even better, where a large chunk of our debt is held by foreigners. The reservations that exist in Japan about going all-in on QE do not exist. Yesterday was proof positive of that and I believe that a meaningful shift in expectations has actually occurred. People anticipate economic activity and growth – witness the move up in interest rates and the action in equity markets. Not to suggest that it will be sustainable and that productive growth will result. Simply, that bubbles will be blown, paper wealth will be created, and at some point in the future it will crater again.
So, the moral of the story: any central bank with full control over a fiat currency cannot possibly fail if the objective is to create inflation.
One last point. Given the above, why have I spent time and money shorting the Yen (with an ultimate aim of shorting JGBs in the future)? Demographics are working against the Japanese and the savings that propped up the bond market in the past are beginning to dwindle. Either they will need to go out to the capital markets to sell bonds (and see rates rise) or they monetize the debt to save their domestic bondholders (and kill the currency). One of those two will happen…eventually :)
