Japan has been in the doldrums since its property bubble blew up more than two decades ago. Recently, a new government introduced a fundamental change in macro-economic policy in an effort to end deflation (a falling overall price level) and stimulate renewed economic growth. If this new policy approach succeeds, Japan will become a much more interesting trading partner for Canada and the world.
Those of us that are over 40 probably remember the times in the 1980s when Japan, not China, was seen as the next global economic superpower. That perception of a rising Japanese superpower proved to be a great illusion. The Japanese property bubble ruptured in the early 1990s, destroying billions of dollars in unrealized wealth and crippling the Japanese banking system.
Unfortunately, Japan’s public policy response was an unhappy mixture of late, inadequate and even wrong-headed action. For more than 20 years, Japan continued with what we consider a fundamental misalignment of fiscal and monetary policies. While Japan eventually found a way to restructure its banking system to deal with the collapse of property asset values, it never really got the mix of fiscal and monetary policy right. Year after year, it tried to use fiscal stimulus to kick-start its economy, resulting in annual fiscal deficits and a high and still-rising mountain of public debt. Concurrently, the Bank of Japan maintained overly tight monetary conditions, fighting against non-existent inflation and feeding deflationary forces.
The result was recurring growth recessions, weak recoveries, but a relatively strong currency. Japanese exporters lost international competitiveness, and the country’s standing as a global powerhouse came to an end – even as many major Japanese corporations were able to keep expanding, usually through business activity outside Japan.
In April, that failed strategy began to change with an announcement (now called Abenomics, after current prime minister Shinzo Abe) that it would introduce quantitative easing (QE) to flood the Japanese economy with liquidity. QE would be used to buy government bonds, driving down interest rates and reducing the value of the yen. QE should also begin to raise domestic inflation, breaking the psychology of deflation and creating improved conditions for sustained economic growth. The International Monetary Fund quickly raised its growth forecasts for 2013 and 2014 to around 1.5% annually, and other Japan watchers are rethinking their forecasts.
The new strategy is already having an impact on the Japanese economy. Real GDP increased at a higher-than-anticipated rate of 3.5% (annualized) in the first quarter, in part because of rising consumer spending linked to improving confidence since the election of Abe last December. Consumer prices increased in March compared with February. However, the path to ending deflation will be long and winding, and confidence remains fragile – as indicated by the dramatic 7.3% plunge in the Nikkei on May 23. A factor behind the drop is the volatility in the Japanese bond market attributable to the QE program.
Many of Japan’s trading partners are not thrilled with Abenomics. The Bank of Japan’s massive bond purchases have driven down the value of the yen, which has depreciated against the greenback by around 25% since last spring and by 10% since the beginning of April alone. This has led to accusations from the world’s major central banks that Japan is deliberately weakening the yen to gain a competitive advantage for its exports. In response, Japan has argued that the weaker yen is simply a byproduct of the fight to end deflation. In fact, the lower yen could help end deflation because it puts upward pressure on import prices.
The weaker yen has also helped boost corporate profits.
It is also important to note that for Abenomics to succeed over the long term the government must address some significant negative structural forces that have undermined growth. Japan has a rapidly aging and shrinking population and a contracting workforce, which weakens the supply and production underpinnings of its economy. It has no real immigration policy, relying on temporary foreign workers to fill holes. Thanks to wrong-headed fiscal policy, Japan has built up a huge stock of fiscal debt at over 200% of GDP. Power supply capacity was sharply impaired by the 2011 tsunami, and few nuclear power plants are back on line. So the road back to sustainable growth will not be easy.
Nevertheless, the shift in macro-economic policy has again made Japan an interesting trade and foreign investment market. Canada has begun preliminary bilateral free trade talks with Japan, and the two countries are now engaged in the Trans-Pacific Partnership, which could be the cutting edge of true free trade in the fast-growing region of the globe. The game appears to be changing in Japan, and Canadian firms would be well advised to pay close attention because there might soon be more than one high-energy dragon in Asia. •
