Abenomics and the Bursting Linker Bubble

Abenomics is something and nothing. The monetary fireworks are looking like nothing. The structural reforms to labor markets are something, but this is the beast that will make the real difference and it needs to be fed more.

The trouble sign for Abenomics is most striking in JGB linkers, though the bursting of the linkers bubble (yanks call them TIPS—“Treasury inflation protected securities”) tells a deeper story of global malaise and a lot of money being wrong-footed with respect to how it is playing out.

It is no secret that government treasuries are a deeply despised asset class. Linkers, on the other hand, had a dedicated following with a good story. The yarn ran like this: if you have epic monetary stimulus, you will eventually have epic currency declines with respect to commodities like oil, gold, copper, etc. These commodity prices will in turn put a damper on economic growth. So you get a combination of anemic demand, and inflated prices. Linkers were made this kind of stagflation outlook.

The story could hold up as long as monetary policy didn’t tighten. Now that the Fed is withdrawing stimulus (in every sense tightening) spot dollar is up and commodities are getting burned. Add to that the secular factors, which really need their own explanation, affecting demand are showing no uptick. Holiday retail sales are abysmal any way you look at them. We need a new macro story because the stagflation tale is tired and wrong.

The global linker bubble across the globe is turning, because money is looking to nominal returns. It is particularly troubling in Japan where the stated goal has been to spark nominal inflation. Have a look at yen-dominated JGB linkers. Yield to maturity is now back to moribund levels consistent with the lost decades.

There is no stagflation, but there is stagnation. This is a story of weak demand, weak growth, and deflation may need to be tweaked if home currencies like the dollar and the yen remain on their current trend and interest rates change their current trend. These two hinges of the story are connected, of course. Regarding currency moves, I can deal with them. Regarding interest rates, I can’t see interest rates rising anytime in 2015. Until I hear more agreement that rates are going nowhere but the same, I’m not tweaking the plot.

The real hope in resolving stagnation is in “structural reforms”—shorthand for government deregulation, dismantling barriers to business operations, and a shot of tax policy to nudge businesses and Mrs. Watanabe in the desired direction.

Abe has made some progress here, notably:

  • Tax measures associated with the Industrial Competitiveness Enhancement Act were passed. Major impact includes the early phase-out of surcharge on corporate income tax and tax breaks for purchases of productivity-enhancing plant/equipment, corporate restructuring, wage increases, R&D, corporate entertainment, and venture capital investments.

  • The Employment Insurance Act was revised to support mid-career vocational training by expanding subsidies for continuing education and child care.

However, a big chunk of the Abenomics plan remains incomplete:

  • The corporate law is not revised to allow more flexibility in corporate governance.

  • Restrictions on contract workers remain in place.

  • The intended reforms expanding rights for part-time workers have not been passed.

  • Hiring skilled foreign workers remains a real pain in the rear-end for Japanese businesses.

  • The power market is unliberalized.

Now you see why Abe took the risk of snap elections, and now you see why Japanese voters cemented his power. They want reform, and even if they have to vote out all opposition, they are going to get it.

Abenomics isn’t about expanded QE or about monetary policy at all. It will take years for these reforms to fully take root, but these reforms are what will change the story in Japan. Some variations of these reforms, adapted to specific national conditions, are needed to change the story everywhere.


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