Wednesday, March 13, 2013

The Abenomics of Japan

The market reaction to the new Japanese Prime Minister has been nothing short of eye opening.  With bold claims to battle deflation and revitalize the Japanese economy through competitive devaluation of the yen, markets around the world have been put on notice.  This is one determined dude.  Without any program of intervention actually underway, and merely a claim to begin fighting the yen sometime next year, the currency immediately entered a spirited decline, dropping from its high of 77.11 back in September to its current low of 96.12.

The Nikkei has rallied in support, reaching a new multi-year high of 12,239 on the promise of new BOJ leadership supportive of Abe's plan.  All that's left now, is for commentators to draw historical parallels to prior "currency wars" and for Christine Lagard of the IMF to declare this a currency issue, but certainly not a war.  China, always eager to jump on the bandwagon of Japan bashing, accused Japan of what the US has accused China of and for which the US is, of course, leading the parade.

As the world is increasingly convinced that all economic difficulties can be solved through currency debasement, we sit here thinking the world has really gone quite mad.  We know the argument.  Weak currencies foster competitive industry in a global marketplace, while stoking inflation as the the local consumer pays more for everything they import.  We get it.  But it's dumb.  At least for developed economies.

For many years, growth in the developing world has been built around this principle. Employ cheap surplus labor to build products that can be sold to rich people in the West.  Local manufacturers cannot compete on price, as to the labor component, and if you can turbo charge it all with a weak currency, so much the better.

But Japan today is quite different.  It is a mature, highly educated and wealthy society, with an enviable standard of living.  It's problems are demographic in an aging and declining population, economic in a heavy government sector debt burden (236% of GDP) and social, in a high standard of living for what was once an export dependent economy.  For the first time in memory, Japan is posting a trade deficit, reversing seemingly endless periods of surplus.

The strong yen was derived in part from a view that despite the country's large budget deficits and high debt burden, a high resident savings rate allowed Japan to largely self-fund its deficits.  No need to rely upon the trade surpluses of other nations to pick up the slack, the way the Chinese and Japanese have so graciously done for the US.

All these historic trade surpluses, however, have put Japan in an enviable position, at least compared to the US.  According to a recent article by Bloomberg News, Japan surpassed China as the largest holder of US securities in 2012, at $1.84 trillion and the second largest holder of US Treasury bonds (behind China) at $1.12 trillion.  In many ways, this makes the Japanese problem less insoluble than that of the US.

Japan should enter a course 180 degrees away from that charted by Abe.  They should begin selling their holdings of US dollar denominated assets and using the proceeds to reduce their own debt.  This "reverse" intervention would cause the yen to appreciate in value, not only through the currency transactions directly but through a perceived strengthening of the currency on the basis of the stabilization of the country's fiscal imbalances.

A stronger yen would hurt their export sector, perhaps, but Japan's real problem with exports (as with the US) is excessive labor unit costs by global standards.  Quite simply put, if Japan wants to compete in the markets for manufactured products that the world perceives to be commodities, without technological or qualitative distinction, it has to lower its standard of living, not its currency.  This, again, is equally true of the US.

A stronger yen, however, will lower the cost of imports for Japanese consumers.  It will stretch their dollar further, so to speak, at home as well.  And it just might break, rather than contribute to the deflationary spiral by stimulating consumption.  Ask yourself: if a Japanese businesswoman needs to fill her car with gas on the way to work and finds that it costs her the equivalent of $70 rather than $110, is she going to delay filling up, hoping that prices are lower next week?  Of course not.

If she saved $40 on gas, is she more or less likely to pick up a nice bottle of French wine with dinner at the market?  Particularly, if it cost the equivalent of $25 rather than $65. And would these lower prices and greater spending power make her feel poorer?  Unlikely.  And if interest rates were raised so she and her family could see their savings rise, this might not hurt their wealth effect either.

A stronger yen would boost final demand rather than weaken it.  And for a modern Japan that can no longer produce the best quality at the cheapest price, internal demand may be far more important to the country's economic future than the old model of currency debasement and export dependence that Abe is preaching.

1 comment:

  1. I don't think Japan should sell US currencies. But there is a shortage of sound collateral for the interest rate swap market so it would likely not be a problem for us.