Abenomics: Now for the Hard Part


If Shinzo Abe wants wage increases, he should start by giving his media handlers a raise. Even before he became prime minister last year, Team Abe was doing a masterful job winning support for their man by taking a Reagan-era name and slapping it on a series of economic policies that have been touted in some form or another by successive Japanese governments for much of the last twenty years.

Now Abe is doing his part. With Thursday’s announcement by the Bank of Japan (BOJ) of unprecedented monetary easing under new governor Haruhiko Kuroda, Abenomics is making all prior Japanese economic policy look positively insipid by comparison. Through Kuroda, Abe has taken Japan into what is very much new territory.

Some of the weekend media coverage of the BOJ’s policy announcement seemed to see aggressive action as signaling Japan had finally joined some sort of quantitative easing club. But comparisons with Kuroda’s peers at the Fed and the Bank of England need caution; the treatment may be similar, but the underlying conditions are quite different. The United States and Britain have been nationalizing private-sector losses from the global financial crisis (GFC). The idea is that the cost of this will ultimately be foisted on to their publics via some combination of higher taxes, lower spending and inflation, ameliorated by higher growth as their economies return to an economic upcycle. You can criticize the policies—many do—but at least that path has been trodden before.

Japan is different. Its banks didn’t suffer large losses during the GFC. Japan’s bubble was 20 years earlier, and those losses have already been nationalized. Rather, Japan is dealing with structural issues, mainly demographics and productivity. Until those issues are resolved—and structural problems need structural solutions, as Kuroda’s predecessors at the BOJ have been trying to tell everyone—Japan will not return to sustained economic growth, which makes the endgame of this massive easing much more uncertain than anything being tried overseas.

Fortunately, Abenomics does call for structural reforms, one of its “three arrows”—from the Japanese proverb “three arrows cannot be broken”—along with fiscal policy and monetary policy.

Of these three arrows, the least interesting is fiscal policy. Abe’s supplementary budget is certainly large, but Japan has done this many times before. Fiscal stimulus typically delivers a temporary uptick in growth, paid for with a rise in Japan’s government debt burden. It has never been sufficient on its own to return Japan to sustainable growth, and its only economic justification at this point is to offset the impact of more painful measures, such as an increase in the consumption (sales) tax. I emphasize “economic justification” because fiscal stimulus obviously has a political role, and Abe is looking to take back a majority in the Upper House elections expected in July.

The second arrow, monetary policy, has had its own problems. The BOJ has been a frequent target of criticism for its alleged timidity in this regard. Some of the criticism seems to benefit from 20-20 hindsight; Japan was, after all, a pioneer with the zero interest rate policy and quantitative easing, but it is true that the BOJ has had an unfortunate tendency to tighten too early.

More importantly, though, traditional monetary policy in Japan has always run into the same problem: even with scads of near-free money available, Japanese companies just don’t want to invest. Why would you, when a shrinking local market means you’re already overcapacity? Worse, the deflation caused by declining demand means that real interest rates in Japan turn out not to be so cheap after all.

So on one level, a monetary policy approach of once more, only this time with feeling, would seem to be just more of the same. But the BOJ has become increasingly unconventional in its choice of tools. What is remarkable about Friday’s announcement is the degree to which it is sidelining Japan’s financial sector, and injecting money directly into the economy. It is doing this by pledging to buy huge amounts of Japan government bonds (JGBs), including for the first time longer-term maturities, by lending directly to companies (with a target that will exceed the combined total of corporate lending by Japan’s commercial banks by roughly 50 percent over the next two years), and by making massive purchases of assets such as exchange traded funds and real estate investment trusts.

No wonder the announcement set markets afire. At the time of writing, the Nikkei was up about 2.4 percent and the yen had weakened roughly 5 percent. The weaker yen in particular will cheer Japanese exporters and those with overseas assets, even if it reduces the real incomes of everyone else.

A few observations on the announcement. First: What are Japanese banks supposed to do? As the Financial Times reports, they are being crowded out of both the JGB market and the commercial lending market. With few other domestic investments, we might expect a considerable spike in Japanese financial sector investment overseas. It is noteworthy that the BOJ on Friday indicated that it would not be buying any foreign bonds—it wants to avoid the accusation that it is intervening directly to weaken the yen. But forced capital flight from Japanese financial institutions could have the same effect.

Second, asset bubbles anybody? The BOJ may be hoping for a wealth effect, but that may come at the cost of steep private-sector losses in later years.

April 11, 2013 at 05:38

CLJF wrote:

April 9, 2013 at 10:13 pm

Liang1a, give it a rest. Off topic, boring and pointless.


How is it off topic?  I'm right on topic.  I said I agree with Pach in that Japan's problem is in the declining productivity and aging.  Obviously, Japan's problem is aggravated by competition from exports.  If Japan can increase its exports several times to trillions of dollars (based on a vastly inceased productivity and competitive quality) then it would not have any problem with its economy.  The Japnese people would be earning hundreds of thousands of income and can enjoy a high level of standard of living.  But since Japan cannot exports due to an increasingly uncompetitive technology and declining productivity, its economy is falling into a hole.  Unfortunately, Japan must export because it must import almost all its energy and all its raw materials.  In the end, Japan must compete by devaluing its yen which will lead to many other problems as I explained in another post.  I post the other post again to illustrate my point about how devaluing the yen will lead to catastrophic collapse of the Japnese economy:

Let's see what happens if the Japnese yen went down to 360 yen per dollar like it was 60 years ago. As of Dec. 2012, the price of hot rolled steal plate is $706 per ton. At 95 yen per dollar this is 67,070 yen. If the yen were devalued to 360 yen per dollar then the same $706 per ton steel will cost 254,160 yen. This means the cost of all imported raw materials in terms of yen will go up 3.8 times if yen were devalued to 360 yen per dollar. Let's say currently, a car made and exported by Japan costs $20,000. This is the same as 1.9 million yen. Let's say 1.5 million yen is due to the cost of imported raw material and .4 million yen is due to the cost of labor. Since the cost of raw materials in terms of yen would have gone up 3.8 times if yen becomes 360 yen per dollar, the raw material would then cost 5.4 million yen. So a car then costs 5.8 million yen to a Japnese car buyer (5.4 million yen for imported raw materials and 0.4 million yen for labor). This means the cost of a Japnese car has inflated by 3 times. If the average salary of a Japnese worker is currently $40,000 or 3.8 million yen then he can afford to buy 2 cars a year for now. But after the devaluation of yen to 360 yen per dollar, the price of Japnese car has gone up to 5.8 million yen. So, the Japnese worker who still make only 3.8 million yen of salary can then only afford to buy 0.65 car. Obviously the Japnese people cannot afford to buy such an expensive car after yen is devalued to 360 yen per dollar. Does this mean that Japnese car is then very cheap in terms of dollars falling by 3 times or more? Not necessarily. The cost of raw materials in terms of dollars is still the same or $15,800 because imported raw materials is paid for in dollars. The value of the Japnese labor then is reduced to $1,111. So the total cost of the Japnese car is then $17,000. This is only a drop of 15% from $20,000 and not the huge drop of several hundred percent down to just a few thousand dollars most people think. So this is not a very big competitive edge.  Also as the value of the yen plunges and inflation rises, the Japnese people will demand huge increases in salaries.  As salaries increase, the cost of labor also increase, and so the cost of Japnese cars still cost $20,000 as before.  So the final result of Japan devaluing its currency from 95 yen per dollar to 365 yen per dollar is only to collapse the standard of living of its own people while barely improving its competitiveness in the global market. And China with improved technologies can increase the productivity of its labor and so maintain the same cost of labor as the Japnese. In the end, China will still out-compete Japan in the global market. The only difference is that the Japnese people will become much poorer than the Chinese people.   

And specifically, a North Koreans who cannot afford a car at $17,000 today will still cannot afford a Japnese car at $17,000 after yen has been devalued by some 4 times to 360 yen per dollar. Therefore, those who think it is a very good thing for Japan if China raises the value of its RMB are in for a very rude shock! China has raised the value of its yuan for some 25% from 2007. In that time the Japnese economy has gone down and not up. Therefore, if China continues to raise the value of its yuan, the Japnese economy will only continue to go down.  In the end, Abenomics will wipe out the government debt by foisting it on the Japnese people.  But he will also bring economic devastation to the Japnese people, especially to those on fixed incomes.   



hot rolled steal plate $706

April 11, 2013 at 02:30

The country's debt had a double whammy of inflation [brain freeze - interest] and a rising currency.

April 10, 2013 at 15:26

James, I think you hit the nail on the head. Let me explain long-windedly. I noticed someone coming to my house as I glanced out the window this morning. It was the gas meter reader. I started thinking, I haven't seen a meter-reader for the gas, electricity or water for years. It dawned on me the meters sent my usage through the internet. I went outside to ask what the problem was. She replied I hadn't used gas for months and wanted to check if my meter was broken. There were no longer any meter readers.

Technology had brought about increased productivity. Moore's law of transistor counts of semiconductor doubling every eighteen months [now every thirty-six months] increased productivity throughout the world. In some countries more so. Nagging unemployment will be around due to rapidly rising productivity. In Japan vis-à-vis the rest of the world, productivity should be higher as the reason for the stubbornness of the high yen relative to other major currency. Yet the figures for the comparative productivity places Japan around about the 20th highest in the world. However this does not take into account of factories in Mexico, China, Malaysia and many other countries. Repatriated profits kept the yen strong relative to the euro and the dollar. Japan's productivity was much higher than the economist's. 

The country's debt had a double whammy of inflation and a rising currency .Japan's overall productivity was unbalanced. Japan's overseas factories became so much more profitable than at home. Even though there was rising productivity, the rise could not cover the low cost of manufacturing in low wage countries. And Japan's overseas factories were profitable due to having a higher productivity compared to the rest of the world. 

Abenomics: The demand for yen will lessen in the short-term. Funds will be invested where there is the highest return. Funds that would have been repatriated have been invested elsewhere. For this to change, Abe had to spend. Unfortunately, funds are not limitless. Eventually the pump-priming will stop. However in the short-term, the capital markets are awash with funds. Where will those funds go? Not in Japanese factories – worldwide demand is low and the COGS is lower elsewhere. Some will go to new overseas production and asset purchases. And some will stay at home in the form of higher real estate and securities. Coming full circle, as the Abenomics just flatly runs out of money, a rising yen will be a better investment to Japanese companies. Nothing ventured, nothing gained. In this case Abenomics is just another way of saying voodoonomics.

Is there an answer to Japan's problems? I have my own voodoonomcs.  LOL

James Pach
April 10, 2013 at 11:30

Thanks for your comments Leonard.

With your questions about inflation, there is a difference between asset price bubbles and inflation as measured by the CPI. With a large injection of money, but few productive investments, I think it is quite possible to see a bubble in equity and real estate prices. At the same time, prices of consumer and industrial goods may not rise so easily, because of demographics and weak investment demand.

In the long term, Japan must use inflation to pay down its debt. Short of a major productivity revolution, there is no other way. The risk for Japan is that it goes from deflation to hyperinflation very quickly.

As for the weaker yen, I agree with you, although I think the benefits of a weak yen for Japan are overplayed and will be short lived.

Leonard R.
April 10, 2013 at 11:10

Tihs is an excellent article by James Pach and your analysis is pretty good too. I don't necessarily agree with all of your conclusions here. But you are spot-on describing the symptoms. 

In one paragraph, you say asset inflation will happen. In the next you say it won't because of demographics and inevitable declining demand. Did you mean short-term asset inflation? But ultimately deflation will triumphing the long run?

What Abe is doing should not be examined in a vacuum. Recent statements by BOC deputy Yi Gang demonstrate that Abenomics is also aimed at China. A currency war with Tokyo causes all sorts of problems for Beijing. For instance, it could trigger even more sanctions and quotas against Chinese goods in developed economies. 

I think Abe knows what he is doing here. The long-term benefits of Abenomics in Japan may be nil or wores than nil. But it could yield abundant foreign policy and external trade benefits for Tokyo. And oh, by-the-way, expensive military projects are a structural reform and could deliver a terrific short-term boost to the Japanese economy. I read recently that Japan within one year, has the technological capacity to produce as many warheads as the US has stock-piled over decades. 

I suspect Beijing is aware of that. 

April 10, 2013 at 03:27

Interesting and timely article. Japan is anomaly when it comes to comparing her to the rest.  GDP: Japan is one of the few countries where construction is at a low percentage. Japan does not need a new airport, new roads, new train systems. What they have is perfectly adequate for their current and near future needs. A decreasing population means eventually closing down train stations which will lead to ghost towns in remote areas. 

The Japanese do not want immigration. You can see how they treat the recent immigrants from Peru, although of Japanese descent, are snubbed as not being "really" Japanese. And they are not, culturally that is. So if Peruvian Japanese are not wanted, can you imagine any other people being wanted? Therefore without a spurt in birthrate, Japan will lose half her population in forty years. And that is not the world's problem and not a problem with the Japanese, however it is a decision by the individual households to forgo having children. Taiwan, Switzerland and several other countries has the same decline in their birthrates.

Asset inflation will happen. Prime the pumps, have the same output [relatively, a few percentage points means little], and the stock market will soar due to companies having more and more cash and loathe to spend it since your valuation grows without risk. Making money the easy way – the government gives it to you. 

Deflation in Japan is a way of life. A declining population means a decline in demand. You just can't get around this fact. What Abe is doing to the economy is very small in relation to the size. He can do a little damage, but what he can do is talk the market up for a time. Eventually, nothing will come out of it. The market will do what the market does best: allocate resources. 

Japan's economy may not shrink, however it will not grow in any appreciable manner. The individual Japanese will be wealthier as we head into the mid-21 century. Nothing wrong with that. It is what is.

Kim's Uncle
April 9, 2013 at 23:43

I like Japan!  It is one of my favorite countries in Asia.  I hope Abe is right but I think going back to Keynesianism is a sad mistake.  Deregulations and helping entrepreneurs to boost the economy would make a lot more sense.  Japanese companies that export their products are super competitive in the marketplace while Japanese companies that only do business domestically are terribly uncompetitive.  This situation should be balanced.  

April 9, 2013 at 22:13

Liang1a, give it a rest. Off topic, boring and pointless.

Robert D
April 9, 2013 at 18:28

This was a very good article, complete and interesting.

For those who would like to compare the analysis, I also found an article written by Joseph Stiglitz (http://www.cfo-insight.com/markets-economy/global-economy/the-promise-of-abenomics/).

Enjoy !

April 9, 2013 at 16:05

The Japnese situation is insoluble.  Japan's problem is aggravated by the fact that it simply cannot be energy independent because it does not have any coal or oil or gas.  It might be able to get a lot of energy from wind power in the Japan Sea or solar power from space-based solar panels.  But America will not allow Japan to be energy indpendent because America wants to sell oil under its control to Japan.  Therefore, Japan is doomed to have a declining economy that will simply continue to tank.  Especially, as Pach pointed out Japan's problem is also caused by stagnant productivity and aging population.  It is also caused by capitalism where people must save for their old age.  In short, Japan's golden age is long over.  And the Japnese cannot look forward to anything but a stagnant economy that will only grow worse as competition for exports increases from developing countries especially from China, Barzil, Russia, etc.  S. Korea has taken a lot of global market from Japan.  Now with China advancing its technologies rapidly, it will take all of Japan's high tech exports from it.  Ultimately, Japan has to rely on cheap labor to compete against China's superior technologies.  I'd feel sorry for Japan except it is so arrogant and aggressive.

China should kick Japan out of China's domestic economy.  Then Japan's economy will collapse and it will have no money to deploy a powerful military to commit aggression against China forever.  I'd like to see what the US can do to revive Japnese economy.  It's a laugh to think the US can revive Japnese economy when the US economy is also dependent on constant blood transfusion from China.  China shuold stop letting these bloodsuckers suck Chinese blood.  Wen Jiabao had been a fool to let these bloodsuckers suck Chinese blood for 10 years.  It is time for Xi to put a stop to this foolish waste of China's economic energy.

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