Is Japan's 'Abenomics' solution working?

During this ongoing global economic crisis, one term which is common is QE by central bankers. Recently every news talks about central banks printing money in response to the global economic crisis. Whether it is the Eurozone, China, U.S. or Japan, every country is printing more money to bail them out of debt. The perception is that the increased money supply will help them grow. Influenced by this strategy Japan’s Prime Minister Japan Shinzo Abe introduced the concept of ‘Abenomics’ to improve the economic condition of Japan.

Abenomics refers to the economic policies advocated by Shinzo Abe. It is meant to resolve Japan's macroeconomic problems. It consists of monetary policy, fiscal policy and economic growth strategies to encourage private investment.

There are two clear objectives that Abenomics intends to achieve. Firstly, Japan was suffering from 2 decades of deflation because of which prices of each goods and commodities kept falling. Therefore, there were no gains to invest in plant and machinery as the output of investment will keep on falling and the debt burden will increase. So, Abenomics committed a level of inflation (2%) that will bring in confidence among Japanese people to spend and invest. Secondly, the supply of yen in the marketplace by central bank of Japan will pull down the value of yen against its trading partners which will help their exports.

Basically, he devalued Yen by pumping in artificial money in order to make exports cheaper. When a currency declines in value, goods produced within the nation become cheaper for foreigners to purchase. A devalued currency can give a country some major advantages in terms of trade and help to boost domestic growth and improve the balance of payments.

The strategy, as of now, seems to be working but pumping easy money in the economy in order to spur price rises, spending and borrowing in an economy that has stagnated for years, will only bring a smile to the market for a short period of time. Eventually for the financial system to grow, it needs more constructive and genuine measures.

Abenomics sure is an initial success; the stock prices have gone up, exports have become cheaper but from a macroeconomic and a long term view it does not give a bright picture. The central bank of Japan will, at some stage stop printing money, the day it stops to bring artificial money into the economy, the chances of the economy collapsing rise exponentially.

One of the other major concerns for Abenomics is hyperinflation. Devaluing the currency boosts the cost of goods and commodities and results in inflation. Excessive devaluation of the currency may result to a situation where the inflation will be out of control. This will lead to hyperinflation. Hyperinflation occurs when a country experiences very high, accelerating and clearly "unstoppable" rates of inflation. Hyperinflation effectively wipes out the purchasing power of private and public savings, hence distorts the economy of the country.

One of the most famous examples of hyperinflation is in Germany between January 1922 and November 1923. By some estimates, the average price level increased by a factor of 20 billion, doubling in every 28 hours.

The third and major concern for Abenomics is the so called “Currency war”. The devaluation of Yen has potentially increased global tensions. Japan’s trade partners including Australia, New Zealand, Philippines, South Korea, Switzerland and Thailand are seriously contemplating devaluing their currencies. Furthermore, the European central bank is also devaluing their currency ‘the Euro’ in order to bail the Eurozone out of the ongoing Sovereign debt crisis (Euro crisis). China, on the other hand, experiencing slow growth can also jump into the same muddy water in which Japan finds itself swimming by devaluing their Yuan (Renminbi) and make their exports cheaper.

The consequences of this currency war can be disastrous as this will trigger retaliatory action among the countries which in turn will lead to general decline in international trade and harm all countries and thereby the entire globe.

Does this currency war affect India? The answer is probably yes. India is linked to all these countries due to globalization and international trade. The FII’s have already brought in a net total of over $14 billion so far in 2013 because they want to invest the freshly printed artificial currency into a developing country like India and aim higher returns. However, the long term horizon looks weak, as eventually, due to factors in their own economies or the drying up of the artificial pool of money, the FII’s could just as easily pull out of India, potentially causing another stock market slide, and thereby the erosion of your savings.

Countries like Japan needs organic growth. Their approach should be to take long term measures for growth rather than short term. They need to re-discover their innovativeness to grow naturally and not depend on their central bank and government to print more money to bail them out. Things will be more difficult if they do not stop this currency war. There is probably only one solution to this warfare, an international peace treaty between the generals in this new currency war i.e. the International central bankers and policymakers across the globe. They need to get together to decide the best way to organically grow their economies, to find a proper solution to this malaise rather than continuing to put their economies on ventilators, where one flick of the switch, one wrong move could culminate in very undesirable outcome.

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