Published in Financial Times 10/2/2014
The yen falls sharply on the foreign exchange markets and, hey presto, within a year we have an emerging market meltdown on our hands. That was the picture in 1996-7, but feelings of déjà vu are misplaced. Japan is no longer the export powerhouse of yesteryear.
At the dawn of Abenomics, some trading partners did indeed worry that Prime Minister Abe was adopting a “beggar thy neighbour” policy that might trigger a 1930s-style breakdown of the international system.
Team Abe riposted that returning Japan to the path of growth would be good for everyone. They were right. Far from launching an export drive, Japan saw its trade deficit well-nigh double last year. Even the current account – bolstered by massive inflows of investment income – recorded a few sizeable monthly deficits.
Special factors explain some of the red ink. Japan’s nuclear reactors, which once supplied a third of the country’s electricity, are all off-line. Filling the gap is three trillion yen’s worth of fossil fuel imports. Prime Minister Abe s plan was to bring the nukes back into operation gradually, having regard to the understandable wariness of a public traumatized by the Fukushima disaster. That approach has been threatened by the re-emergence of former prime minister Junichiro Koizumi, who has lived up to his maverick reputation by re-inventing himself as an ardent anti-nuclear campaigner.
In the grand scheme of things, does this matter much? Probably not. Trade and current account surpluses have little correlation with economic performance. In the 1960s, when Japan was as growing as rapidly China has been recently, it often recorded deficits. In the lost decade of the 1990s, when the economy lurched from real estate meltdown to banking crisis, the external accounts were strongly in the black. Japan’s bulging current account surplus, the slump in equities and real estate and the decline of bond yields to multi-century lows all reflected the reality of an economy incapable of absorbing its own savings.
At some point Japan will shift to current account deficits again, as the excess savings – now mainly in the corporate sector – are absorbed by rising consumption and investment. Like many other countries, it will then need to attract foreign capital. The implied normalization of bond yields is something to be desired, not feared, as it will follow on from the normalization of nominal GDP growth.
Japanese investors have been content to hold government bonds at very low nominal yields not out of some bizarre form of financial patriotism, as is often assumed. Thanks to deflation, real yields were internationally competitive. Thanks to the collapse in credit demand and long bear market in risk assets, there was no domestic alternative. Now thanks to Abenomics these malign forces are finally being rolled back.
There have been important changes in the corporate sector too. Traditionally Japanese companies cut export prices in periods of yen weakness in order to steal a march on overseas competitors. This time despite a currency depreciation of 25% – much larger than the pound’s after it was forced out of the ERM in 1992 – there has been little increase in export volumes. Instead more confident and shareholder-sensitive managements are prioritizing margins over market share.
These days the manufacture of the commoditized products in which Japanese companies lack pricing power is mostly done off-shore. The currency is less relevant for the booming auto industry too. In 2007 it produced roughly the same number of cars in Japan as overseas. Now overseas production is 80% larger. Honda, for example, now exports more cars from the US than it brings into the country.
The proof of the pudding is in the earnings. Consensus expectations are for the earnings per share of the Topix Index to rise by almost 100% between March 2012 and 2016. No surprise, then, that the Japanese stock market has just chalked up its strongest performance in 40 years. The well-publicized travails of some of the great names in Japanese electronics are no longer representative.
Make no mistake – Japan is now ferociously competitive. On some calculations of its real effective value, the yen is at its cheapest level since currencies started floating in the early 1970s. Foreign tourists have cottoned on quickly. Arrivals have soared to an all-time high – with the Chinese especially prominent, despite the political stand-off between the two nations. Businesses take far longer to change their plans than holiday-makers, but if the yen remains close to current levels an industrial revival is on the cards.
What if it doesn’t? What if emerging market contagion takes the yen higher and the asset markets lower? In such a case expect a strong response from the Bank of Japan, including significantly larger purchases of Topix ETFs, also a renewed emphasis on fiscal policy, including corporate tax cuts.
Japan’s reflationary challenges are almost the mirror-image of the problems besetting the emerging economies. Rather than struggling to hold up a falling currency, it wants to put an end to the yen’s safe haven status. Rather than stopping the outflow of foreign capital, it is trying to encourage the vast pools of risk-averse domestic capital to venture overseas. Rather than dealing with the aftermath of a credit bubble, it is trying to support the nascent, long-awaited recovery in bank-lending.
As the history of the last two decades shows, doing nothing is dangerous. Putting the pedal to the metal is actually the low risk approach.
Japan needs Abenomics to succeed – and so does the rest of the world.