Ad Hoc Commentary – Abe’s third arrow

The front cover of the latest edition of The Economist features a picture of Shinzo Abe’s head superimposed as a traditional Japanese archer:

http://www.economist.com/printedition/2014-06-28

The magazine praised the success of Abenomics’ first two arrows: the JPY10.3 trillion fiscal stimuli and the BoJ quantitative easing. However, Abenomic’s third arrow had been underwhelming since Jun 2013. Despite that, the beauty of the Japanese people is their perseverance. The proponents of Abenomics are still trying as we write and yours truly hope that the latest blueprint brings us closer to the promised economic recovery:

“…Japan’s government approved a blueprint for structural reforms put forward by Shinzo Abe, the prime minister. This is the ‘third arrow’ of Mr Abe’s economic programme, known as Abenomics, the aim of which is to revise Japan’s economy…”

http://www.economist.com/news/world-week/21606007-politics-week

Any politician worth his salt will think of Plan B just in case the economic third arrow fails. Let us not be naive about this. The economy matters and political fortunes as measured by statistics like approval ratings depend in no small part on a vibrant economy. One of the oldest tricks when the economy is not doing well is to create a diversion from the daily toil. We heard of the phrase bread and circuses (latin: panem et circenses). War is, in a sense, the extreme form of diversion. It is thus very concerning that Japan’s cabinet is reinterpreting the pacifist constitution against of backdrop of economic stagnation:

“…Japan’s cabinet passed a resolution expanding the role of the military to include the defense of allies, reinterpreting the pacifist constitution in place for nearly 70 years, Defense Minister Itsunori Onodera said…”

http://www.bloomberg.com/news/2014-07-01/japan-s-ruling-parties-agree-to-allow-military-to-defend-allies.html

Only a true pessimistic will think that a country that had first-hand witnessed the power of the atom during the 1940s will ever contemplate a ‘belligerence arrow’. However, the problem with the history of the world is that peaceful nations sometimes get pulled into war against their will. In a world where the power of the atom can level cities in seconds, there is probably going to be no victor to enjoy the spoils of war. Instead, there will likely be massive suffering on both sides of the border. However, that doesn’t stop the overly optimistic, that look at the world wars through rose tinted glasses, to entertain dreams of becoming the ultimate victor to enjoy the ultimate spoils of war.

It is probably much better for everyone if the world is not hobbled by another arms race, and these monies are instead being used for development. Sovereign balance sheets are already overstretched across the globe. We do not need a new cold-war type arms-race to stretch sovereign balance sheets even further. The next crisis is likely to be precipitated by sovereign debt, just as the last one was precipitated by mortgage debt.

Our favorite S&P500 had made new highs overnight and yours truly had been missing out on it. Yours truly is happy staying out and wait out for better levels to re-enter in the coming weeks. The equity correction, if it comes, is likely not THE crash. The ultimate crash would likely be driven by defaulting sovereign debts and the catalyst is likely a US government shutdown discussion which is not due till Sep/Oct 2015. America is still the prettiest among the pack. Let us hope we solve the problem of constrained sovereign balance sheets in the increasingly short time that we have. A sovereign debt meltdown is not in the interest of the common good.

Good luck in the markets.