Published in Newsweek Japan 12/2/2013
Compared to the usual pace of Japanese policy-making, Abenomics has been moving with the smooth celerity of the new Hayabusa bullet-train. The world has watched in amazement as in a matter of weeks the Tokyo stock market has soared by a third and the yen has fallen substantially against all major currencies.
The effect on economic activity will soon start to appear. Major exporters like Toyota and Panasonic have already revised up their earnings forecasts. One convenience store chain has even announced a 3% wage hike for staff aged between 25 and 40 – the kind of event that has become as familiar in post-bubble Japan as snowfall in Okinawa.
Inevitably such a dramatic change in direction has produced doubts and outright opposition, both in Japan and overseas. Is Japan doing something unethical, or even dangerous? You might think so from the comments of Angela Merkel and the op-eds in the New York Times and other American newspapers.
The reality is quite different. Japanese policy is belatedly adopting what has been the standard practice in the rest of the world for a very long time. Furthermore, the possibility of Japan “going bankrupt” is as close to zero as makes no difference.
Much of the criticism has been stirred by the rapid depreciation of the yen against the dollar and euro. By making that an explicit goal of policy, the Abe administration has engaged in the monetary equivalent of “political incorrectness.”
Since the Lehman shock in 2008, most countries have adopted easy monetary policies that inevitably lead to weaker currencies and greater industrial competiveness. But generally they do not say that is what they are doing. The “honne” and the “tatemae” are carefully separated.
The one exception has been Switzerland. Once so proud of their strong currency, the Swiss finally decided enough was enough. In 2011, the government drew a line in the sand at 1.20 to the euro, beyond which it will not allow the franc to rise. The plan worked. Strengthening a weak currency is no easy matter, but weakening a strong currency is child’s play. You just print more of it.
Amongst the larger countries, it was the ex-Governor of the Bank of England Sir Mervyn King who came closest to admitting the truth. In 2009 he stated that a weak pound would be “helpful” in rebalancing the UK economy.
Other countries have preferred to keep a low profile. A good example is South Korea which has skilfully managed the won in a way beneficial to its exporters. Of course companies like Samsung and Hyundai have made tremendous progress in the quality and range of their products. But it is no coincidence that their global market share took off in the late 1990s, after the won plummeted against the dollar and the yen.
Several emerging countries have fixed their currencies against the US dollar at undervalued rates. Thanks to a super-competitive yuan, China was able to rack up trade surpluses that were proportionately more than double Japan’s highest ever. Chinese factories were more often suppliers to companies like Walmart and Apple than direct competitors to American manufacturers – which is why there was no repeat of the trade friction hysteria of the 1980s.
Being logical people, the Germans went one step further and permanently locked countries like Spain, Italy and Portugal into a single currency. Since these countries had structurally higher inflation than Germany, it was inevitable that German exporters would come to dominate the markets of southern Europe.
Even with their economies in a desperate state, these countries cannot depreciate their way back to competiveness, as Korea did after the Asian crisis. For them the euro is like the cockroach motel – you check in, but you can never check out. Even now, the German current account surplus is 6% of GDP – by far the highest of any large country.
The greatest government-directed manipulation of currencies took place in the mid-1980s at the behest of the United States. The Plaza Accord and the Louvre Accord engineered a massive appreciation of the yen and the deutschemark against the dollar – with the purpose of boosting American competitiveness at the expense of Japan and West Germany.
Over time it succeeded. Indeed it was Japan’s attempt to stimulate domestic demand after the yen had doubled in value that stoked the bubble economy and set the scene for the lost decades.
In other words, currencies are always highly political. Governments like to assert that the exchange rates should be left to market forces, but that is a fiction since the supply is monopolized by governments themselves.
It is particularly hypocritical for other countries to slam Japan for weakening its currency since the yen has traditionally been one of the hardest currencies in the world. The US dollar, in contrast, has been falling steadily in both nominal and real terms since currencies started floating in 1971
Over the past five years, the competition to weaken currencies has become fiercer as governments grow more desperate in their attempts to kick-start growth in a world of stagnation and rising unemployment.
Japan, by contrast, has endured a further significant appreciation of the yen against all currencies. This is despite suffering one of the largest blows to economic activity since the Lehman shock.
The refusal of the Bank of Japan to follow the rest of the world in aggressively expanding the money supply guaranteed that the yen would surge. If the Abe administration is successful in changing the culture of the central bank – and it hard to change any institution without radical changes in personnel – the era of yen strength will be over. On the other hand, if he fails then the whole Abenomics project will dissolve like a midwinter night’s dream.
It used to be said that a strong currency was a kind of national virility symptom – likewise a weak currency is the mark of country in decline. That was true in the age of inflation, when double digit rises in the cost of living led to strikes, hoarding and social unrest. But in the last age of deflation – the 1930s – it was the other way round.
The countries that exited the gold standard the earliest – the equivalent of depreciating their currencies in those days – recovered the quickest. Those that continued with hard money policies suffered increasing unemployment and loss of competitiveness. Minister of Finance Taro Aso is right to refer to the precedent of Korekiyo Takahashi, the finance minister who took Japan off the gold standard eighty years ago and used deficit spending to reflate the economy.
At the time there were many people critical of “Takahashi-nomics” – to the extent that he was eventually assassinated in the 2.26 incident– but his policies quickly produced results. As none other than Ben Bernanke stated, Baron Takahashi “brilliantly rescued Japan from the Great Depression.”
What if Abenomics goes “too far”? Won’t some kind of financial apocalypse occur? It is true that current level of Japanese bond yields is only compatible with a shrinking economy. If the Japanese economy returns to healthy growth, long –term interest rates should be 2% or 3%.
But that will only happen there is sufficient demand for borrowing at those rates – in other words, when companies are sufficiently confident in the future to increase capital investment and the labour market is tight enough to generate higher wages. Sure, banks will lose money on their holdings of bonds, but that will be offset by the rise in value of stock holdings and the massive uplift in the value of their loan books.
As for the yen, a severe decline is unlikely – but if it did happen, the effect on Japanese manufacturing could be similar to the effect on Korean manufacturing of the collapse in the won. Companies can rise like phoenixes from the ashes of defeat. Fifteen years ago both Apple and Samsung were fighting for survival. In another fifteen years maybe some of the great names of Japanese electronics will have recaptured their former glory. Or perhaps, a currently unknown company will have risen to global prominence.
Whereas Korea was bankrupt in 1997, Japan is a massive creditor nation, with net foreign financial assets equivalent to around 55% of GDP. When the yen slides, the value of these assets rises in yen terms. So a sharp decline in the yen would actually strengthen the balance sheets of many Japanese companies and institutions.
The real risk is not that Abenomics goes too far, but that it doesn’t go far enough and the improvements in the financial environment are reversed. Sometimes being cautious is actually dangerous.
Economic recovery should not be a scary prospect. What is genuinely disturbing is the way people become accustomed to shrinking horizons and see difficulties and obstacles at every turn. Japan’s deflation is mental as well as financial. Overcoming it means penalizing the worriers and doomsters and rewarding optimists and risk-takers.