Published in the Nikkei Asian Review 15/3/2016
To paraphrase Mark Twain, reports of the death of Abenomics are greatly exaggerated. Three years into Prime Minister Shinzo Abe’s reflationary program, the transformation of Japan’s economic climate is undisputable. In 2015 Japan recorded the highest rate of nominal growth in gross domestic product since 1997 and the proportion of the working age population actually employed is at an all-time high. Pay is starting to respond; hourly wages for part-timers are up 2% on the year, the best increase in donkey’s years.
Even so, the going is getting much tougher, mainly as a result of events elsewhere. Over the past six months global growth has faltered and deflationary pressures have intensified. In order to keep reflation on track, Abe will need to reconfigure his policy mix.
Specifically, Japan can no longer rely on a weakening currency. Since the dawn of Abenomics, the yen has acted as a financial version of the “wind of the gods” – the fortuitous typhoon that destroyed the fleet of would-be conqueror Kublai Khan in the late 13th century. To an economy inured to an ever-appreciating currency, the decline in the yen-dollar rate from 80 to 120 was an extraordinary, barely hoped for blessing. The benefits swiftly flowed down to the profit margins of exporters and the cash registers of retailers dealing with a burgeoning influx of foreign tourists.
This year’s reversal, which has seen the Japanese currency retrace roughly a quarter of its decline, happened because nervous global investors have poured capital into “safe havens,” such as government bonds, gold bullion and the Swiss Franc as well as the yen. A safe haven may sound desirably snug and secure, but in a deflationary world a strong currency increases vulnerability to economic headwinds, rather than acting as a bulwark against them. In 2016, the profits of exporters are going to suffer and the bakugai (“explosive purchases”) of Chinese tourists may well turn into damp squibs.
GOING SUBTERRANEAN
To fill the gap, Abe will need to use fiscal policy more actively. At a minimum he needs to postpone the scheduled hike in the consumption tax and bring on additional spending worth 1% of GDP. Given the tightness of the labor market, hikes in the minimum wage and better terms for part-time workers could also inject spending power directly into the economy.
Meanwhile, the Bank of Japan can broaden its asset purchases and cut Japan’s already subterranean interest rates even further. Other things being equal, this should weaken the yen, but in the world of financial markets, equal is what other things never are. This year the main driver of the yen dollar rate has been the decline in US bond yields, which has overwhelmed the changes in Japanese monetary policy. If required, more radical measures could be contemplated. Outright cancellation of government bonds bought by the BoJ under its quantitative easing programme would slash Japan’s public debt-to-GDP ratio while surely putting the kybosh on the yen’s safe haven status.
All these moves are controversial. Japanese fiscal policy is under the control of the all-powerful bureaucrats of the Ministry of Finance and their acolytes in politics and international organizations. For such men – and they are all nearly male – austerity is not an economic policy but a creed imbibed with their first cup of green tea in government service. For justification they can point to Japan’s Mount Fuji of government debt and still substantial deficit.
That position, though, is far from unassailable. Over the past 18 months Japan’s current account balance has rebounded from small deficit to a surplus equivalent to 3.3% of GDP. This means the country is more than self-financing and the chances of incurring a Greek-type debt crisis, as widely mooted by the fiscal hawks a few years ago, are negligible.
Furthermore the tax authorities have an embarrassing secret they clearly do not wish to ventilate. Japanese tax revenues (general account basis) are absolutely booming, up 10% over the previous 12 months. It is crystal clear that to stand any chance of closing the fiscal gap Japan needs continued growth in nominal GDP, not an austerity-induced recession.
BORROWERS DO NOT WANT TO BORROW
The BoJ’s introduction of a negative interest rate policy in late January has met substantial pushback from the financial industry, as in Europe, on fears that banking margins will be hurt and savers will remove their deposits. It is unclear how much these risks matter. Credit growth has been weak in so many countries not because banks are rejecting lending opportunities on grounds of profitability, but because borrowers do not want to borrow. In Japan, in particular, the supply of savings vastly exceeds demand for loans. Negative rates are an attempt to change this unhealthy equilibrium by making borrowing cheaper and cash hoarding less attractive, especially for corporations. In that sense it is a more orthodox procedure than quantitative easing.
The verdict so far? The Bank of International Settlements concluded a recent report on negative rates in Europe by saying that “zero has not proved to be a technically binding lower limit for central bank policy rates. Nonetheless there is great uncertainty about the behaviour of individuals and institutions if rates were to decline further into negative territory.” In other words, the jury is still out.
The BoJ has not gone anything like as far as the ECB or the Swiss Central Bank, which have taken rates down to minus 0.4% and minus 0.75% respectively. With its rate at minus 0.1%, the BOJ still has plenty of room to move. Since the introduction of NIRP there has already been a surge in applications for mortgage refinancing, while purchases of overseas bonds have taken off. Meanwhile the Japanese stock market has risen a few percentage points in dollar terms, with the real estate and construction sectors among the top performers. Watch this space.
A SECOND WIND
The G-20 meeting in Shanghai at the end of February supplied Abe with the political cover he needs to reinforce his economic agenda. According to the joint statement, member countries pledged to use “all policy tools — monetary, fiscal and structural — individually and collectively” to strengthen the global economy. Probably few will follow through, but Abe has every incentive to lead the way.
Later this year he has the opportunity to call a joint “double election” of the upper and lower chambers of the Japanese Diet. Another landslide victory would secure his place in the history books and allow him to proceed with his cherished project of revising Japan’s pacifist constitution. All he needs is a strong proposition — and what better than money in people’s pockets combined with the cheapest housing loans in human history?
It is worth remembering that Kublai Khan’s fleet was destroyed by the wind of the gods not once, but twice. After the second time, the great Mongol conqueror got the message and gave up. To defeat deflation for good, Japan needs a second typhoon — one whipped up by a more radical economic configuration