Published in Nikkei Asia 31/3/2022
Have you heard about the great Japanese discount market that offers exclusive deals to foreigners? It’s worth taking a look at the bargains on offer. Prices have been slashed by 50% across the board. Where is it located, you ask? The answer is in every town and city in the country.
In real terms, which takes comparative rates of inflation into account, the yen has more than halved since 1995, leaving it at levels not seen since the early 1970s.
Yes, the yen hit 122 to the US dollar 30 years ago, much the same as the foreign exchange rate today, but a 2022 dollar is by no means the same as a 1992 dollar in terms of buying power. Consumer prices in America have doubled in the intervening period, whereas prices in Japan have actually fallen.
As a result, Japanese products and services have become extraordinarily cheap relative to the American equivalents, as have wages, rents and many asset prices. The same goes, to a greater or lesser degree, for Japan’s other trading partners.
Real trade weighted yen: 1971-2022
In the Covid era, only a trickle of overseas visitors have been able to enter Japan, which has probably obscured the scale of the phenomenon from foreign eyes. If and when the world returns to a semblance of pre-covid normality, Japan will surely experience the mother of all tourist booms. But the economic effect will be much more profound than that.
Expect to see Japanese managements choose onshore rather than offshore production, already a priority given the new sensitivity to supply chain management and economic security, thereby raising the level of domestic investment. Expect to see “import substitution”, as Japanese consumers avoid expensive foreign goods in favour of cheaper domestic equivalents.
Perhaps most significant will be the effect on energy policy. With the great majority of its nuclear power plants offline since the Fukushima disaster of 2011, Japan has to import about 90% of its primary energy requirements from overseas – nearly all fossil fuels shipped from long distances. The surge in global energy prices, already underway well before Russia invaded the Ukraine, has been painful – and also comes as a timely reminder of Japan’s strategic vulnerability.
In economic terms, Japan is experiencing a sharp shock to its “terms of trade”, meaning the price of its imports relative to the price of its exports. The oil, natural gas and coal that it buys now cost much more, while the autos, machine tools and imaging chips for smart phones that it sends overseas are flat or mildly higher in price. By further weakening the Japanese currency, the market is compensating for the trade shock by increasing the competitiveness of Japanese exports.
In the short term, yen weakness exacerbates the problem of high energy prices, but also incentivizes change. One kind of change is simply reducing energy intensity (energy used per unit of GNP). Japan’s energy intensity is already lower than most European countries’ and just 65% of South Korea’s, but necessity is the mother of invention. In the 1970s, Japan reduced energy intensity by 30% over ten years, at a time when the export juggernaut was running full tilt.
At the time, sho enerugi (“save energy”) became a national watchword and air-conditioners and escalators were shut down in offices and stores. Today’s Japan is a different, more individualistic place, but companies and households will be sensitive to their soaring electricity bills. New work-rounds for economizing on electricity will appear spontaneously. The controversial topic of Daylight Savings Time – the merits depend greatly on geographical position – may well get a further airing.
The bigger story is that the greater the rise in fossil fuel prices, the more competitive the alternatives become. The two obvious contenders are nuclear power and renewables. Before the triple disaster of 2011, nuclear supplied 14% of Japan’s total energy needs and 30% of its electricity, which was expected to rise to 40% within a few years. Given that the most important costs are sunk, the currently offline capacity should be brought back on stream as soon as possible.
That will take delicate handling of public opinion and Fumio Kishida, Japan’s ultra-cautious prime minister, will probably wait until the Upper House election this July before risking any political capital. The EU Commission’s recent decision to categorize nuclear and natural gas as “sustainable” might give him some cover.
From there, the next decision will be about building a new generation of nuclear power plants. They could be of the small modular type developed by US company NuScale Power, which has a joint venture with Japanese engineer JGC Holdings, or of a more conventional kind.
Renewables have an important part to play too. Japan’s topography may limit some of the technologies, such as solar panels and onshore wind, that are operating at large scale in other countries. Floating offshore wind farms could be an ideal solution as winds are stronger and more reliable away from coasts. Still, the technology is in an early stage and will probably not make a significant contribution for several years.
The weak yen is working to accelerate these largely positive trends, but there are clear negatives too – often the other side of the coin. If tourists find Japan cheap, Japanese people will find foreign countries expensive and stay at home. If salaries are low, foreign companies might find Japan cost competitive enough to make it an Asian hub. On the other hand, highly-skilled Japanese might go overseas for better pay and highly-skilled foreigners might choose opportunities elsewhere.
Significant movements in currencies generate significant and complex effects, but it is the nature of contemporary politics and media commentary that most of the discussion is about the downside. At the very least, the yen no longer has the designation of “safe haven currency”, which sounds like a compliment, but was in fact a curse. In 2011, the yen-dollar rate spiked to 78 even though the Japanese economy had just been crippled by the earthquake, tsunami and nuclear meltdown. One of the undoubted successes of Bank of Japan Governor Haruhiko Kuroda’s much looser monetary policy has been to eliminate such harmful absurdities.
It’s also possible that there could be a sharp reversal in the currency markets at any time. After all, this is not a new phenomenon. In real inflation-adjusted terms, the yen has been on a zigzag downward path for the past twenty seven years. Usually the currencies of countries with low inflation are stronger than those with high inflation, yet the latest reading for CPI inflation in Japan is 0.9% against 7.9% in the U.S. That is the largest differential since 1980. On that score, it’s the dollar that is “soft”, not the yen.
So be warned. If you are thinking of patronizing the great Japanese discount store, don’t take too long to make your mind up. The bargains will not be there forever.