Japan, The Economic Conundrum

In recent times, a lot of focus has been put on the Japanese Yen as the economic conditions of the economy seem to improve under the guidance of Shinzo Abe and the Bank of Japan’s (BoJ) Governor, Haruhiko Kuroda. However, are these gains actual after a year, or is Japan really just talking up the economy while it remains stagnant? Is the ever-present deflation still a threat?

The reality of the Japanese economy is hard to grasp. Over the last year, we saw the introduction of Abeonomics. This was followed by an aggressive Japanese government which went about devaluing the Yen in an effort to stimulate the economy. Since Abenomics came about, the Yen has fallen over 20% versus its major counterparts, this has been seen as excessive and has created a stir across the G8, as major countries worry about their economic competitiveness. This has been led in part by a massive stimulus programme by the BoJ, which has been a complete paradigm shift away from the traditional methods used. (Historically, the BoJ has used currency intervention via foreign reserves in order to drive down its currency, or initiated small stimulus packages.) However, a massive change was required after deflation weighed on the Japanese economy over the last decade, and more aggressive policy-making was mandated.

Abenomics came into play, and the BoJ was directed to act more aggressively or face government changes. The BoJ responded by announcing a stimulus of 5 trillion Yen, the largest in the history of Japan. The markets had been moving in anticipation of such a move and were catapulted further upwards against the Yen, while foreign capital flooded into the Nikkei as investors anticipated the outcome of booming export markets in line with a weaker Yen.

The Yen has since settled around the 95-100 mark versus the USD. This is seen as positive for an export-driven economy such as Japan’s. However, there are costs for such a sudden drop in a short span of time. The purchasing power of Japan has dropped significantly, leading to a much wider trade balance as Japan’s exports have taken longer than expected to pick up. The reason for this is that Japan’s once-dominant export economy has many other competitors in the form of South Korea, China, Indonesia and Vietnam. Non-existent 30 years ago, these countries are now paying close attention and have threatened to devalue their currencies in return if they feel economically threatened.

The Trade Balance though has a much more significant impact at home in the Japanese consumer market. A widening trade balance reflects the drop in purchasing power for the local population as import costs rise dramatically and as such, the Japanese population is worse off than it was a year ago. Additionally, sales tax is to be increased from 5% to 8% – seen as a step in the right direction by economists in order to help fight Japan’s debt conundrum. In 2015, Shinzo Abe is expected to raise this tax to 10% in order to keep his hard line on the economy and fulfil promises which he made to get into power. In the past, such a tax has led to a recession as soon as it was implemented, leading to the prime minister at the time getting quickly ousted. Nevertheless, Shinzo Abe is confident that a 5 trillion Yen stimulus will help alleviate the pain of any such tax and help offset any chance of a recession.

The inflation rate has been the key metric in all of this though. Japan’s whole mandate has been about fighting deflation and ending the plague of weak inflationary growth of the last 15 years. Recently, Japan was seen to have been a success story when CPI data came out 0.8% in August, as compared to the less encouraging results of last year. However, when taking into account this figure, it has been primarily driven by an increase in food and energy costs, both of which lifted as the Yen fell against its major trading partners. So when taking these out of the equation, we see that in reality, the CPI is -0.1%. This implies that the economy is not creating the healthy sort of inflation that is required to beat deflation.

This in turn has prompted Shinzo Abe to ask corporations to keep pace with the recent drop in real wages. However, corporations so far have said that they would not increase current wages, they might however increase bonuses in a small minority. So this leaves a problem in the Japanese economy as wages don’t match inflation, leading to people being worse off in the economy, especially as their purchasing power weakens. The real fear in the lack of increase in wages is that consumption may drop off. With a tax making things more expensive and wage growth going backwards relative to inflation, any drop in consumption in a developed economy has large ramifications and can lead to potentially negative effects.

What this mean for the Japanese economy is that there are now more calls for additional stimulus for the economy, by relatively the same order of magnitude or more, in an effort to keep up the aggressive strategy that has been laid out for the economy. Such aggressive action is likely to stir sleeping giants such as China and the US into speaking out or looking to impose restrictions in an effort to stop any sort of currency war.

So is Japan’s economy better off due to Abeonomics? Well, it’s actually very hard to tell at this stage. So far, it looks like the changes in the economy have had a drastic effect which might not actually lead to anything of benefit to the people of Japan. It will take a while to see if the results are positive, but the main fear is certainly a drop off in consumption, as wage growth does not grow with the economy and in line with inflation. Such a scenario would cause a negative chain of events which could damage the Japanese economy and create financial turmoil. However, for the most part, deflation looks to be fought off if the Yen keeps dropping and consumption does not decrease. This is an unlikely scenario though as the further Yen weakness, the more it will hurt the economy. Nevertheless, things are looking up in the near term. But the long term essentially looks very troubling when you consider the policies in place.

Written by Alex Gurr, Currency Analyst at Blackwell Global