The 2010s for Japan: comeback like Sinatra or lost decade round two?

The future: the volatile road ahead for the world's 3rd largest economy.

JAPAN, LIKE a phoenix rising from the ashes, ascended from its knees after the Second World War into one of the world's major economic superpowers and industrialized nations in a generation. By the mid 1970s - early 1980s, Japan had effectively 'caught up' with the USA and Europe technologically and economically, especially in its key export sectors of ICT, automobiles, consumer electronics and other heavy industry. Its conglomerates posed as a major threat and competitor to Western counterparts. But unlike its Asian neighbours of South Korea or Taiwan, Japan never fully managed to shake off the detriment of the bursting of the bubble in the early 1990s, the Asian financial crisis of 1997 and the collapse of semiconductor prices at the end of the 20th century. The fact that many Japanese firms are particularly dependent on the domestic Japanese market (such as firms in the telecommunications and semiconductor sectors) also exacerbates the problem for them. 

From an economics perspective, the central bank  - Bank of Japan  -  was partially to blame. Interest rates still remained high during the late 1990s and Bank of Japan's failure to lower the interest rate fast enough resulted in a liquidity trap - a cause of stagnation. In an attempt to stimulate the economy, Japan (unsuccessfully) during this period of time ran into large budget deficits on public works projects. Japan then suffered several episodes of deflation into the new millennium; the success of Bank of Japan's quantitative easing program which began in 2005 only proved to be short lived as far as GDP growth figures of the period show.

The 1990s, what was in fact an American decade, was the lost decade to Japan. The country, which exhibited miracle growth was now in a state of crisis and decline. 

Fast forward to 2013, little has got better for Japan overall. 

This week, Japan's economic woes has been hitting the financial press headlines again. At the beginning of the week, the Bank of Japan after a 2 day meeting announced that it will implement no new quantitative easing, other monetary policy tactics or offer bond buys. Disappointed and left volatile, the Nikkei fell 6.5% entering a bear market territory while global markets also responded negatively to the news; markets were further not convinced by Bank of Japan's governor Kuroda's insistence that growth is coming and that no imminent tool is needed as a result. The yen rose nearly 2% against the dollar. It seems to me that Japan's lost decade is far from over. 

Could 'Abenomics' give Japan a comeback like Sinatra? 

PM Shinzo Abe, who came into power last year, is an advocate of going 'all out' to stimulate economic growth, private investment and battle the Japanese economic plague that is deflation.  His vision, consisting of the 3 arrows approach -  dubbed as 'Abenomics' -  involves the Bank of Japan playing more of a monetary policy role. It is also entails more fiscal policy moves including heavy government spending and the Bank of Japan engaging in aggressive  asset buying. The third arrow involves structural reforms, seen as the foundation to Japan's comeback. Abe believes that the mobilisation of an aggressive monetary policy and fiscal policy will stimulate growth, triggering a round of private investment into plants and people. In turn, expectations of growth and prices will start to rise, successfully combating inflation. 

Since a landslide victory in November 2012 that resulted in Abe becoming Japan's 6th leader in 7 years, Abe has been following through with what was on his manifesto. He forced through a 10 trillion Yen increase in government spending on infrastructure  healthcare, education and other spending- this is believed to boost Japan's growth by 2%.  This week, Japan's cabinet is voting on the '3rd arrow policies' under 'Abenomics' involving income raises, attracting foreign investment and a reduction on investment tax to help companies boost their capital spending. 

But, the Bank of Japan's actions, or rather, lack of actions this week does not concur with 'Abenomics', casting some doubt on whether 'Abenomics' is actually plausible in reality. 

Of course, it is too early to judge the long term effects of 'Abenomics' and whether any growth (such as the 1% growth of Q1 2013) is here to stay. 

Looking holistically, the Nikkei has gained more than 70% since mid-November and the Yen lowered by 22% to the dollar and the euro. Also in this time period, the difference in yields between 5-year Japanese government bonds and their inflation-indexed equivalents has increased by over 1 percentage point. This could be indication that Japan is on an overall path to growth and inflation, leading to a rebound in consumer spending, hiring and other private investment.  Further, earnings predictions for Japanese firms are higher than compared to 6 months ago, but only based on the belief that Japan's GDP figures will continue some form of growth. 

For the Japanese economy, inflation is good news. There has been a surge of inflation in recent month, but this is actually driven wholly by a planned increase in consumption taxes that will begin in 2014. Similarly, data from the Tokyo Stock Exchange shows that the Japanese have been selling shares to foreigners for months. For me, this would say that any inflation/price increases is due to foreign demand and not changes in the the portfolio allocations of Japanese savers. 

Another point to suggest that there has been no real economic progress (since Abe's election) is that Japanese households and firms, who own more than $6.7 trillion worth of non-Japanese assets (37% are bond investments), are not moving their money out of these foreign assets into domestic ones. They would surely do so if Japanese savers genuinely believed that Japan's prospects had improved. A lack of investment by foreign investors in Japanese assets is also a sign that Kuroda and Abe are not convincing many. 

To me, Abenomics has not made a modest reversal, but a minute one. This is because what is needed is more fundamental structural changes to the economy that accompanies aggressive monetary and fiscal tactics to pull Japan out of a lost decade, such as:

•  Public sector debt. Japan’s ratio of government debt to GDP is around 2.28 (and increasing), the highest out of all the industrialised nations by far. To put into perspective, it is almost double that of Greece and Italy. Further, the combined costs of interest on debt and welfare are equal to total government tax revenue. Reducing its public debt can spark some consumer and business confidence. Raising tax is not a good option but Abe believes that economic growth as a result of 'Abenomics' can make public debt appear more manageable. Impression management is no good - it is the doing that counts. 

• Demographics. Japan's working age population has shrunk every year since 1995. Because working age people are the biggest spenders, an ageing population has inevitably reduced overall demand in the economy. A vicious but not virtuous cycle appears - the lower retail sales lead to businesses engaging in cost cutting (common in  Japanese firms) which lead to lower wages and lower prices. Japan can begin by boosting the work force such as creating incentives for more women to re-enter work after employment, encouraging more marriage and couples to have more children or relaxing its immigration policy; immigrants can also change expectations of growth and inflation.

• Deflation mindset. As well as the above, Abe has the challenge of convincing inflation expectations beyond financial markets and into households and firms; many agree that there is a deflation mindset in Japanese households and businesses who all hoard cash and other assets rather than spend.

Japan may not have a comeback like Sinatra in this decade, nor perhaps the next. But there is a sense of optimism about Abenomics, and this, coupled with some fundamental structural changes, Japan can steer itself back on to the road to growth. This needs political will. In the mean time however, Japan is still trapped in a lost decade. 

JH