The Japanese denial story – Part 2

Here is Part 2 of my analysis of the claim that Japan is not a good demonstration of what happens when macroeconomic policies are pushed beyond their usual limits. I have long argued that trying to apply a mainstream macroeconomics (New Keynesian) framework to the Japanese situation yields nonsensical predictions about rising interest rates, accelerating inflation, rising bond yields and government insolvency. Nothing like that scenario has emerged since Japan has introduced economic policies that ran counter to the mainstream consensus since the 1990s. Japan demonstrates key Modern Monetary Theory (MMT) principles and those that seek to deny that are really forced to invent a parallel-universe version of MMT to make their case. That version is meaningless. In Part 2, we extend that analysis to consider trade transactions, the fear of inflation, and the argument that the current generation are selfishly leaving their children higher tax burdens while we party on.

Here is – The Japanese denial story – Part 1 (January 3, 2022) – which you should read prior to Part 2 for context.

We ended Part 1, with the observation that it is always possible for a nation to experience a sudden change in its external circumstances if the positive net exporting countries decide they no longer want to accumulate financial assets in the local currency.

Sudden changes rarely happen and advanced nations have run permanent external deficits for decades without experiencing the adverse consequences from global financial markets.

In order to fully understand how trade occurs and why it does not particularly matter who holds the debt issued by a currency-issuing we begin Part 2 by tracing the actual transactions that coincide with an international trade transaction.

You will learn that the funds never leave the local currency financial system unless the holder ultimately converts them through the foreign exchange market.

Following our example yesterday, here is a transactional account of how this works which starts off with a US citizen buying a Chinese product:

  • US citizen buys a Chinese manufactured car from a local dealer.
  • If the US consumer pays cash, then his/her bank account is debited and the car dealer’s account is credited – this has the impact of increasing foreign savings of US dollar-denominated financial assets. Total deposits in the US banking system, so far, are unchanged.
  • If the US consumer takes out a loan to buy the car, then his/her bank’s balance sheet now records the loan as an asset and creates a deposit (the loan) on the liability side. When the US consumer then hands the cheque over to the car dealer (representing the Chinese firm – ignore intervening transactions) the Chinese car company has a new asset (bank deposit) and my loan boosts overall bank deposits (loans create deposits). Foreign savings in US dollars rise by the amount of the loan.
  • So the trade deficit (1 car in this case) results from the Chinese car firm’s desire to net save US dollar-denominated financial assets and sell goods and services to the US in order to get those assets – it is the only way they can accumulate financial assets in a foreign currency.

What if the Chinese car company owners then decided to buy US Government debt instead of holding the US dollar-denominated bank deposits?

Some more accounting transactions would occur:

  • The Chinese company would put in an order for the bonds which would transfer the bank deposit into the hands of the central bank (US Federal Reserve) who is selling the bond (ignore the specifics of which particular account in the Government is relevant) and in return hand over a bit of paper called a bond to the Chinese car maker’s lawyers or representative.
  • The US Government’s foreign debt rises by that amount.
  • But this merely means that the US Government promises, on maturity of the bond, to credit the Chinese car firm’s bank account (add reserves to the commercial bank the car firm deals with) with the face value of the bond plus interest and debit some account at the central bank (or whatever specific accounting structure deals with bond sales and purchases).

If you understand all of that then you will clearly understand that this all merely amounts to substituting a non-interest bearing reserve balance for an interest-bearing Government bond.

That transaction can never present any problems of solvency for a sovereign government.

The US consumers get all the real goods and services and the Chinese have bits of paper.

I know some so-called progressives worry about the stock of debt that the Chinese are holding.

But the US government holds all the cards. The debt, in our example, is in US dollars and they never leave the US system.

The Chinese may decide they have accumulated enough and will seek to alter the real terms of trade (that is, reduce its desire to export to the US).

In that situation the US will no longer be able to exploit the material advantages and the adjustment might be sharp and painful.

But that doesn’t negate that while the situation is as described the material benefits are flowing in favour of the US citizens (overall).

So the fact that the Japanese government debt is held by Japanese residents or resident companies and other nations have their debt held by foreigners is largely irrelevant from the perspective outlined above.

What foreigners do with those local currency financial assets leads to different narratives.

If the asset holders are allowed by government, for example, to use those local currency assets (say, an account balance at a local bank) to speculate in local real estate markets, then we might reasonably be alarmed and seek ways to prevent such transactions.

Some nations have foreign investment review processes which seek to regulate what a non-resident can and cannot purchase.

But if the local currency funds derived from the export surpluses are used to purchase government bonds then there are no particular issues as we saw above.

The cries that China funds the US government, as part of some sinister narrative that implies that government is beholden to a foreign power, are meaningless.

The government can spend whenever it chooses – given it issues the currency – and the servicing and repayment of the debt liabilities are the same, irrespective of whether the holder of the debt is a resident or a foreigner.

The debt is repaid by crediting bank accounts in the local currency.

The situation is different, however, if the government issues debt denominated in a foreign currency. That is a path to trouble. It relies on the nation being able to generate sufficient export revenue to ensure it has the foreign currency reserves necessary to service and repay the debt.

But, of course, that is not a distinction that applies to either Japan nor the US.

The hyperinflation is just around the corner and about to get us story

Takatoshi Ito argues that:

… the Japanese government need not, and should not, default on its debt. Even if there are no buyers for it, the Bank of Japan can continue to purchase new and rolled-over bonds with cash injections. This may invite very high inflation. But MMT advocates would say that bond issues can be stopped if and when the inflation rate exceeds 2%.

The first part is correct.

And the Bank of Japan can always control yields and/or just buy all the debt.

In the last decade or more, all new debt issued by the Japanese government and a substantial portion of debt previously issued has ended up being held by the Bank of Japan as a deliberate policy.

This ‘may’ do a lot of things, but high inflation is not one of them.

For more than two decades, the Bank of Japan has been effectively funding the treasury side of government – don’t be mislead by the optics of primary issue auctions that put an institutional smokescreen over what is happening.

The Japanese government issues an instruction to spend X yen on something and the Bank of Japan ensures the appropriate accounts are credited to allow the funds to be transferred.

So where is the inflation?

New Keynesians predicted it in the 1990s.

They had another go in the 2000s.

Now in late 2021 (when the Op Ed was published) they are still predicting it – although the wording is now ‘may’ rather than will.

Any global inflationary pressures at the moment are pandemic-related and will eventually dissipate (if we solve the pandemic and/or adjust our behaviours).

Further, MMT economists do not say that “bond issues can be stopped if and when the inflation rate exceeds 2%”.

If anyone says that they are not being faithful to our work.

We say – there is no need to issue government debt any time! Full stop.

There is no conditionality there.

So the rest of his analysis based on the 2 per cent rule is barking up the wrong tree.

But let’s consider the argument he makes that debt matters?

He claims that given the large outstanding stocks of government debt, the government would have to impose “massive and sudden” fiscal austerity “to pay for the redemption of existing maturing bonds”.

Not in any world I inhabit!

The Bank of Japan would just mark up one account (debt repayment and reserves) and mark down another (bonds outstanding).

No austerity needed – just some typing.

If there was sudden and massive fiscal austerity imposed, then, of course, there would be a “sharp recession”.


Any other option?

The don’t you get it – inflation is coming story

Well, Takatoshi Ito says that:

The only other option would be for the BoJ to continue to buy up the debt, which would result in still higher inflation, if not hyperinflation.

Like, all the inflation Japan has experienced since 1990, that is!

It becomes comical when we have had around 3 decades of a nation struggling to record positive inflation rates (that is, above zero) and regularly has recorded deflationary outcomes, for the mainstream economists to keep saying that when the central bank purchases government debt, issued to match (not fund) a fiscal deficit, that inflation, or hyperinflation will result.

It is time to give up on that one.

It is interesting how these sorts of Op Eds start modestly and by the time we are getting to the end, the hype expands – not just inflation but hyperinflation is Japan’s destiny – or mass unemployment.

And now our kids will have to pay the piper story

Having dropped the inflation thing into the mix, Takatoshi Ito turns to the intergenerational burden thing:

Cash transfers, such as the one just approved, and other programs benefit current generations, whereas the tax burden of eventual bond redemption will be borne by future taxpayers – many of whom may not yet be alive. And even when existing bonds are rolled over indefinitely, interest payments for debt-financed current consumption will be borne by future generations.

Each generational vintage (comprising the voting public) chooses its own tax burden through the governments it elects.

The previous generation cannot impose upon the current generation any particular tax schedule, although inertia does militate against change.

For my generation, the tax burden is much lower than it was for my parent’s generation.

And that is a common element around the world.

But the public infrastructure I have access to as a result of large public investments in education, health care, transport, utilities, etc made before I was born have provided me with a much higher quality lifestyle than my parents enjoyed.

So where is the burden?

My parent’s generation encouraged governments to invest in nation-building so that their children would be better off in material terms.

The neoliberal generation of adults (me) are trying to do exactly the opposite, which will undermine the future amenity that we leave behind.

More on that soon.

Further, governments do not pay back their debt liabilities by increasing taxes at some point in time.

They mark up and mark down accounts.

Clearly, at some point in history, tax burdens can rise and fall.

But that has little to do with the trajectory of fiscal policy and debt issuance in the past.

I talked about future amenity above.

The actual burden that the current generation places on the future generation relates to real resource use and exhaustion.

If we destroy the planet now, then our future generations will have a depleted outlook.

That is the intergenerational challenge and it will need much larger fiscal deficits into the future to solve it – through green transitions and the like.

Further, the ageing society in Japan, that Takatoshi Ito considers will “soon” lead to a collapse in the Japanese old age pension scheme, is a problem.

But the problem is not that the government will soon run out of money and not be able to pay the pensions etc.

The reason it is a problem is that there will be less producers of material goods and services and more consumers. The real value of the pensions – what is available for them to purchase – may be depleted.

Which means the next generation will have to be more productive than the last, or else society will have to seriously downgrade its material aspirations – both will be desirable of course.

Balancing that material imperative with the environmental imperative is the biggest challenge facing humanity once the pandemic abates.

And trying to impose ‘sound finance’ principles now on Japanese fiscal policy (along the lines advocated by Takatoshi Ito) will likely undermine the very institutions that will enhance that future productivity – education, training and health institutions – and create technological and other solutions to the climate challenge.

The Japanese government has just proposed in its supplementary fiscal statement a cash transfer of ¥100,000 (around $A1200) to residents under 19 years of age.

The likes of Takatoshi Ito think this is scandalous and will drive the country broke.

I would rather predict it will help Japanese families cope with future education and training demands to ensure their kids maximise their potential.

It certainly won’t send the government broke.

The point of the intergenerational debate is that it is based on false principles.

The intergenerational transfer is about real resources not $ or yen and not whether the gross public debt ratio is 250 or 251 per cent.


Takatoshi Ito presented a very curious argument which urged Japanese politicians not to give:

… a blanket endorsement of MMT and its policy implications …[which] … is the last thing Japan needs.

The fact is that many senior members of the government in Japan are becoming familiar with our work and are seeing the opportunities that a better understanding of how the monetary system operates and the consequences of different policy actions gives them to improve well-being and retain electoral popularity.

The approach taken by Takatoshi Ito which involves (a) Build a straw house; (b) burn it down – is a very conventional approach when there is no substance in the perspective adopted and where history has shown it to be errant.

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.

This Post Has 19 Comments

  1. “The fact is that many senior members of the government in Japan are becoming familiar with our work and are seeing the opportunities that a better understanding of how the monetary system operates and the consequences of different policy actions gives them to improve well-being and retain electoral popularity.” Would that we had an enlightened political party here.

  2. @Carol Wilcox
    Green MP Caroline Lucas appears to have taken an interesting step in this direction:

    “…The UK government has created £895bn of new money using QE since 2009. In the process it effectively cancelled a similar amount of UK government debt. That means that the real level of government debt is not the £2,300bn that the government claims it to be, but something like £1,400bn. Importantly, this new QE-created money does not have to be repaid. This is because one arm of government, the Bank of England is electronically creating it to be used by another arm of the government, the Treasury, and that never has to be unwound.
    When managed appropriately, this approach is not inflationary. In fact, around the world the QE era has been associated with exceptionally low inflation. The current inflationary spike has been more about supply chain disruption than money creation….”

  3. Carol, the full capture of the Fourth Estate in UK means, as we saw in GE2019, the Gov itself is a creature of those who control its Fourth Estate. Pretty obvious that MMT is being deliberately omitted from public economic discourse, not least by using the long standing propaganda model that Chomsky had to point out to a confused Andrew Marr in that famous interview 😉

    No Fourth Estate = no democracy = where we are.

    (Notable that Japan apparently not quite as far down the rabbit hole.)

  4. Great piece Bill. Love the use of Rule / Example method of getting your point across.
    Just curious…how would you advise countries that do not have their own currency? What of the EU? Take measures create their own currency? Adapt to the modern world in other ways?

  5. Excellent Bill,

    All of which was just common sense after the wall street crash in the 1920’s up until the 70’s and then they have reversed back to how things were pre 1920’s. Moved back towards economic rent seeking and neo feudalism. In true Orwellian style like they use the word freedom nowadays they called it neo liberalism.

    They’ll be no Watergate type scandal ever again as the leisure class have learned from their mistakes and just bought up all of the media to control it. Nobody holds the leisure or political class to account anymore. In true Orwellian style they use the press to get rid of anybody who threatens their control. To the point that Tony Blair gets a medal from the Queen for war crimes and Julian Assange has been locked up for 10 years for telling the truth and exposing those crimes.

    Which reminds me of the Frankie Boyle quote…

    “Not only will America go to your country and kill all your people, but what’s worse I think, is that they’ll come back 20 years later and make a movie about how killing your people made their soldiers feel sad.

    America making a movie about what Vietnam/ Iraq did to their soldiers is like a serial killer telling you what stopping suddenly for hitchhikers did to his clutch.”

    When you apply the 2 ice cream sellers on a beach analogy to politics you can see how they control it.

    Back in the 1920’s a guy called Hotelling started to look at Monopolistic competition in terms of location and used the example of where would 2 ice cream sellers on a beach locate themselves. From a social point of view you would think they should locate themselves about one quarter way in on one side of the beach. The other seller would do the same at the other end of the beach. So that they divided the market in two and the consumers could access the ice cream. You would end up with a long beach with a seller at each end a quarter way in on the beach.

    Hotelling then says let’s assume the ice cream sellers are mobile and one ice cream sellers moved a bit closer to the centre. In terms of distance starts to steal some of the consumption of the other seller. Which then forces this seller to move a bit closer to the middle of the beach to try and get it back. Hotelling noticed that what happens is eventually you end up with both sellers right in the centre of the beach beside each other. This is not optimal from the stand point of those in the long beach that would like to buy ice cream. The social optimum for the consumers and that is have the seller’s spread out across the beach has been destroyed by the competition between the 2 sellers. The 2 sellers will eventually come to a monopolistic agreement regarding their prices.

    Then Hotelling says what happens if a 3rd seller sets up on the beach. Everything becomes unstable as the 3 sellers set up in different places on the beach every day and prices become unstable. Until eventually all 3 end up in the same place in the beach and work together.

    Why in cities you have districts that sell the same product. You would expect them to be all over the city but you end up with Jewellers all in one area. Pubs and nightclubs, shopping centres, DIY stores.

    So Hotelling said where do political parties position themselves in terms of the electorate. Do you stay on the far left and far right for example. Or if you move a little bit to the middle you can steal some of the votes from your competitors. With a 2 party system just like with the ice cream sellers you end up 2 parties in the middle of the beach representing the monopolistic ruling class. Add 2 or 3 more parties they also gravitate to the middle. So you can actually see the process playing out today in front of our faces with the Greens and SNP.

    Until you end up with what Christopher Hitchens described as Democratic Centralism in his article in the Nation

    That poses no threat to the leisure class whatsoever. Turns democracy into a complete sham. In which they then use economics to control us.

    How they did it was When the world moved off the gold standard they saw that as a real opportunity some economists would call it the law of comparative advantage. When they moved off gold and into US treasuries they handed the Americans all the power they ever wanted.

    They moved everybody into US treasuries but made them act as if they were still using the gold standard and fixed exchange rates. Didn’t update their economic textbooks to reflect the new normal and became religious priests in the art of propaganda. Used economics and the media they bought to control the voters within their own borders to protect the leisure class.

    Takatoshi Ito 9/10 will describe what happens either under a gold standard or fixed exchange rates. Which is normally the case with mainstream paradigm. Still teach economic students this nonsense today. 9/10 countries act like that today. It was a textbook case of economics being used to control other nation states and the EU took it to a whole new level of control and gold standard, fixed exchange rate submission.

    However, like all laws of comparative advantage it was built on myths. Among the best sayings of George Orwell, “There are some things only intellectuals are crazy enough to believe” takes a place of honor. LCA is one of these things.

    We could give the “mainstream” economists the benefit of the doubt. Maybe they do not really believe LCA — just pretend to believe it. For some noble purposes, like getting a tenure. Intellect restored, but scientific integrity a little under par.

    Today’s “free trade” is not only the last remnant of laissez-faire — it is its least deserving remnant, full of wholesale foul play, deception, currency manipulation, predatory techniques, and other violations of its rules, with the perps not even trying to conceal those violations. To call the existing international trade “free,” and to use LCA to justify it, is the top of unscrupulous audacity. it is very hard to understand how people of integrity can do it and then call themselves “scientists.”

    Unless, you use the MMT lens which exposes their economics of control for what it is, an advantage they had for a few decades that is suddenly being brought from the shadows and into the light and being exposed as the scam that it has always was. Created in cupboards at the Pentagon and CIA to drag nation states to believe in the Washington consensus.

    As the ice cream sellers on the right of the beach move even further right and the ice cream sellers on the left follow them. Turning it into a very dangerous beach indeed. The whole beach becomes unstable.

  6. “The approach taken by Takatoshi Ito which involves (a) Build a straw house; (b) burn it down …”

    That’s a good one! I’m going to use that one when I discuss MMT with people!

  7. Martin, QE is not for treasury.
    QE is the Central turns bond balances into reserve balances.
    Reserves do not enter the economy.
    QE is just how the banks profit by flipping bonds since their usual spread of profit taking from interest rates spread has dried up.

    Reserves stay in the reserve (central) bank.

  8. @Mark
    My point, in quoting Caroline Lucas, was that this is the first time a leader of a UK political party has openly taken a few steps in the MMT direction. She effectively said let’s not worry about national debt. Unlike Rachel Reeves in the LP.

  9. @MartinD I agree that we have to find some cheer in a politician of some standing if not influence in the UK, showing some capacity to think outside the mainstream and take steps in the right direction, something Starmer’s PLP prove incapable of. Incidentally, Lucas is the Green’s only MP, but the co-leaders are Carla Denyer and Adrian Ramsay.
    By contrast, a Professor and expert on infectious diseases has recently been given space in both newsprint and radio to give his expert opinion on the damage of lockdown, but also tag on an ‘inherit a record-breaking mountain of debt’ comment as if it was scientific fact rather than nonsense. Voices like Lucas are needed to counteract the insidiousness with which the mainstream infects public thought or rather thoughtlessness.
    Another really thought provoking blog. Re: ‘For my generation, the tax burden is much lower than it was for my parent’s generation.’ The burdens have been completely rearranged. The wealthy have a lower tax burden and benefit from capital gains. The poor may have a lower tax burden, but have even more of their earnings taken by rent/mortgage, student loans and being charged for pretty much everything to join in society.
    ‘If the asset holders are allowed by government, for example, to use those local currency assets (say, an account balance at a local bank) to speculate in local real estate markets, then we might reasonably be alarmed and seek ways to prevent such transactions.’ Here in the UK, it is unfortunately not only our real estate in which the government actively encourages foreign wealth distortion, but our national game. I’m talking about football of course, since our cricket administrators have shown themselves quite capable of distorting and blowing up that game without foreign money.

  10. Just because the Green party says don’t worry about the national debt doesn’t mean they have changed. Judge them by their actions which in Scotland and elsewhere has been complete surrender.

    The Greens should worry about their government’s performance

    Oh dear Scottish Greens, so soon?

    As per usual, they told the voters what they wanted to hear to get their votes. As soon as they got a little bit of power they have done a complete 360 On 95% of what they promised. Tony Blair wearing a green jacket.

    The second the Americans apply a little bit of pressure on their economic policies and tell them under no circumstances are they going to be implemented. They will fold along with their green ideals they apparently love so much. Start looking for a seat in the Lords earning £500 a day.

  11. Derek, if you do a ‘complete 360’ you end up travelling on your original path. And I know the US has influence but stop blaming everything on ‘the Americans’. If your politicians won’t stand up that is their fault. Don’t blame it on America. The US is not going to attack Scotland or any part of the UK for that matter. Not anytime soon at least.

  12. Jerry,

    I attack the British Empire with just as much passion in case you didn’t notice.

    It’s called free speech. I’m allowed my point of view.

    My very honest view is America is the problem. I wish more people and countries would be brave enough to say it and stand up against the war mongering oligopoly that owns America INC.

    All I suggest using my free speech is that people should spend more time looking through the MMT geopolitical, foreign policy lens. Which is very often ignored in my very honest opinion. They can then come to their own conclusions.

    If that makes you feel uncomfortable Jerry. Good that’s the whole point, that’s what the MMT geopolitical, foreign policy lens is supposed to do. Instead of people just using the MMT lens within their own borders like a comfort blanket.

  13. @Derek
    I wished merely to draw attention to Lucas’s statement which I felt should be noted. I was drawing no other conclusions about the Green Party or it policies about which my knowledge is quite vague.

  14. The UK Greens still believe in UBI, and a Supreme Monetary Court run by luvvies who will decide how much parliament can spend, because cabals of self-appointed experts have such a great track record.

    When it comes to the economy the Greens, the LibDems and Labour believe the country is best run top down like the Donkey Sanctuaries their supporters are so fond of.

    With the rest of us being the donkeys – to be patronised and looked after, as long as we’re the right sort of donkey.

  15. “The US is not going to attack Scotland or any part of the UK for that matter. Not anytime soon at least.”

    You might want to look up Joe Biden’s recent comments about Northern Ireland. He is already complicit in damaging part of the UK.

  16. @Neil Wilson. My comment that it is moderately cheering to see the Green Party’s MP showing signs of non-groupthink thought on economics, should in no way be taken as a Green Party endorsement. They are, as you say, still running with the UBI nonsense etc.
    @Derek Henry. ‘America is the problem’. A very major player certainly, but its coersive power is not sufficient excuse to give others a pass. Also, China doesn’t make out that it is currency constrained and at the behest of the wealthy class, but the use to which it puts resources both inside and outside its boundaries is also a big problem.

  17. Yes, Neil, I’d forgotten about the Green’s UBI nonsense. There was an interview with Varoufakis in last week’s Morning Star which I’m still intending to respond to – selling the snake-oil again. I heard him making a pitch for UBI on Newsnight years ago and thought he must surely have disowned it by now.

  18. Another nonsense article misinterpreting MMT in Project Syndicate from Koichi Hamada (The Power and Poison of MMT)

    What I find so amusing about these economists, is that they just can’t get their head around the idea that the Job Guarantee *replaces* interest rate adjustments and means we can sack the cabals of unelected wonks that currently stroke their beards under the influence and dream up numbers.

  19. I know very late to comment, but …
    I posted a link to these 2 articles on another discussion forum. Yesterday I got a reply.

    The guy thanked me for posting it, and then claimed that Bill had failed to take note of the systematic lying by the BOJ about the inflation numbers in Japan since the 1970s.
    I have no knowledge about this and it would be hard for me to confirm.

    I hope Bill replies or talks about this claim someday.

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