Published in the Financial Times 16/3/2015
If Parisians think they’ve already had a surfeit of Asian tourists, they are in for a shock. The Japanese experience is that first visible sign that quantitative easing is having an effect on the real economy is a massive surge in Chinese visitors lured by the bargain basement currency.
As the Eurozone embarks on its programme of aggressive monetary reflation, there are larger lessons to be learned from the Japanese precedent. Probably the most important is the need for patience, amongst both politicians and the general public. The first years could be bumpy.
Prime Minister Shinzo Abe took office in December 2012 and Japanese “QQE” (quantitative and qualitative easing) kicked off in April 2013. So far GDP growth has been patchy – mainly due to the ill-judged VAT hike of last April – and recent opinion polls reveal little feel-good factor at street level. In fact, however, Abenomics has already delivered tangible results and the economic mood is set to brighten considerably as real incomes turn positive and output rises. If all goes well, something similar could happen in the Eurozone over time.
To be sure there are significant structural differences between the Eurozone and Japan. First, Japan has not turned to large-scale immigration as a cure for demographic shrinkage and even in the darkest days of the lost decades, there was nothing like the astonishing levels of youth unemployment that has blighted southern Europe. The labour market has tightened under the Abe administration to the extent that there is now a job for anyone who wants one. This goes a long way to explaining the remarkable fall in the suicide rate over the past several years, which has reversed nearly all of the sharp increase of the late 1990s.
Second, Japan is a relatively egalitarian country in terms of wealth distribution. The proportion of financial assets held by the richest 10% of the population is the second lowest amongst the 46 countries surveyed by Credit Suisse Research Institute. As a result there has been no political brouhaha about effect of QE on inequality. Polls give Mr. Abe an approval rating of over 60%, which is well-nigh unprecedented for a Japanese leader after two years in office.
Furthermore until the election that brought him to power, Japan had been in a severe multi-decade bear market for both equities and real estate. When your entire stock market is trading at a discount to book value, the risk of inflating an unsustainable bubble is not going to be a serious issue.
Last, Japan does not suffer from the Eurozone’s unique problems of uncoordinated fiscal policy and political resistance to financial transfers from surplus to deficit countries. It has a free hand to do what it wants when it wants. The European Central Bank may be able to copy the first of Mr. Abe’s famous three arrows, monetary easing, but there is no Eurozone equivalent of his second and third arrows, fiscal policy and structural reform.
So what has Abenomics achieved? Undoubtedly, the prime effect has been the sea-change in financial markets driven by QQE. The stock market has doubled in just over two years and the yen has fallen to the lowest level in real trade-weighted terms since the dawn of floating currencies in the early 1970s. Moves of this magnitude are certain to have powerful real economy effects – though gauging when and where they appear is no easy matter.
In the past Japanese exporters have been quick to use bouts of currency weakness to cut prices in overseas markets and grab share from competitors. This time, though, they reaped the benefits of the super-competitive yen through higher margins. Perhaps it was because they didn’t believe the currency move would last; perhaps it was because they wanted to rebuild profitability. Either way, the result was record margins and flat industrial output. Thankfully, though, the last few months have seen a notable pick-up in export volumes.
Likewise, corporate profits used to be a good leading indicator of capital investment, but here too behaviour has changed. Japanese companies have been become much more sensitive to the risks of building unwanted capacity or overpaying for trophy assets. The combination of declining capital investment and resurgent profits has increased the return on Japan’s capital stock to levels not seen for forty years. Again, there are tentative signs that the corporate mindset is becoming more positive, with over a dozen major companies having announced plans for “reshoring” or expanding production in Japan already this year.
Interestingly, the BoJ’s regular survey of corporate managements puts the 10 year inflation expectation at 1.6%. On that basis continuing to hoard zero-return financial assets is a mug’s game and companies should be preparing to put their cash flows to work.
In Japan’s case the first two years of reflation were spectacular for financial markets, but the benefits for the average man and woman in the ramen restaurant were less obvious. Even so the tight labour market gave them more job security and choice than has been the case for years. Now they are likely to be rewarded for their patience as the real economy improves.
For the Eurozone with its 18 million unemployed, more skewed distribution of wealth and menagerie of political extremists, the risks are far greater. The key question is whether it has the political maturity and social capital to get through a waiting period of several years in which the gap between the insiders and the excluded widens dramatically.
In time, though, positive effects should percolate through. Greece, with a tourism industry equivalent to 20% of GDP, could be a big winner – though the locals may need to learn Mandarin to maximize the opportunity.