JAPAN: THE MARKETS DETECT A PAPERING OVER OPERATION

6/14/13

The Japanese stock market has done a round trip since the Bank of Japan, embarking on its leg of “Abenomics” two months ago, started buying everything in site…bills, bonds, even stocks.   The yen has also done a similar round trip since the monetary leg of Abenomics made its debut in April.   Real measures of the Japanese economy seem to be holding up; first quarter GDP growth was 4.1% and the employment picture is brightening, but the financial markets’ reaction to Mr. Abe’s reflation plans do not bode well.

While we don’t know yet how the embryonic experiment we call Abenomics will turn out, one suspects that Abenomics, which boils down to spending lots of money, watering down the yen, and supposedly embarking on structural change in the Japanese economy,  is doomed to failure because, aside from the obvious shortcomings of the first two measures, it is running smack into Japan’s overwhelming problems of demographics and cultural change, the latter not for the better.

Even before Prime Minister Shinzo Abe announced that he was throwing out the rule book and taking drastic action to turn Japan’s economy around, Japan’s public debt/GDP ratio, at 220%, was the highest in the developed, and probably the entire, world.   The Japanese could get away with such brobdingnagian spending because they also had the highest savings rate in the developed world for much of the post war era; as recently as 1990, the savings rate in Japan was 44%.   (See my 4/9/13 post, THE NOT SO INCREDIBLE SHRINKING YEN, for further discussion on these points.) While the government’s spending huge amounts of money is rarely salubrious for the economy, the negative impact is muted when the government can tap such enormous savings to satisfy its more lascivious impulses.  

But the numbers that supported a big spending government have changed markedly in the last 25 or so years.  With a rapidly aging population and cultural changes (i.e., exposure to the West, and especially America, and our free spending ways), the Japanese savings rate is now down to 2%, which is considered healthy only in America.  At the same time, an aging population demands more government services.   So those who used to lend the government money are now tapping the government’s coffers for income and services, as we all do when we age.  Further, younger Japanese are not emulating their elders’ big saving ways; they are starting to spend like Americans.   Simply put, the Japanese can no longer service a debt load that was predicated on a young and saving population now that it has an old and spending population.   Servicing the normal increase in government spending brought about by demographics would have been tough enough, but spending even more to “stimulate” the economy is simply unsustainable.

Despite these demographic realities, Mr. Abe decided that the Japanese could continue to spend like it was 1985 and essentially create the money to do so.  The latter would have the ancillary benefit of weakening the yen, thus improving the Japanese “terms of trade,” policies that back in the ‘30s were derisively and justifiably called “beggar they neighbor.”  Some could argue that the policy worked; first quarter GDP growth was strong, but that was the FIRST quarter, before Abenomics was implemented.   Things are slowing down and the Japanese stock market, with its inherent foresight, is taking a beating.  Strangely, though, the yen, as I said in the first paragraph, is strengthening and, 94.67 to the dollar, is about where it was at the end of March after trading over 102 to the dollar in May.   This not only run counters to the foreign exchange goals of Abenomics but also seems to defy logic; the yen should not be strengthening when the BOJ is creating so many of them.

Meanwhile, the third leg of the Abenomics stool, economic restructuring, has so far been disappointing.   High hopes for corporate tax reform and modifications of onerous employment rules have been dashed.  

So the Japanese government is spending and printing lots of money.   The real economy appears to be responding, but it’s too early to tell how much of the first quarter’s resurgent growth can be attributed to policies not implemented in the first quarter.   Structural reform has so far been disappointing.   And the proverbial, and trite, 900 pound gorillas, high debt, demographics, and the partially attendant declining savings rate, still loom.

Would it be a surprise if creating lots of yen and spending them didn’t solve the problems of a once great nation?