Will “Abenomics” bring real growth to Japan’s economy?

Market Realist

Japanese exports: Are we seeing an "Abenomics"-led recovery in Japan? (Part 2 of 5)

(Continued from Part 1)

Japan’s economy versus the U.S. economy

The below graph reflects trends in Japan’s gross domestic product (GDP) measured in U.S. dollars as of 2005 and 2013. Japan’s Gross Domestic Product (GDP) in 2012 was approximately $6 trillion USD, versus the U.S. GDP of approximately $16 trillion USD (so Japan’s economy is approximately 38% the size of the U.S. economy). Japan’s population is approximately 128 million people, versus the U.S. population of 316 million people (so Japan’s population approximately equals 40% of the U.S. population, on a land mass 11% smaller than California).

Japan’s pre-2012 GDP was stable despite a strong yen

As we noted in the prior graph in Part 1, during the 2002–2008 business cycle, Japanese merchandise exports nearly doubled, mitigating the effects of a weak and deflationary domestic economy. The question is, can the Japanese export machine repeat its 2002–2008 performance in 2013–2018 and reinvigorate its lethargic and debt-laden domestic economy?

Bear in mind that the exchange rate of the Japanese yen in 2005 was around 120 per dollar. The yen subsequently strengthened to record highs of around 80 yen per dollar by the end of 2012, putting intense pricing pressure on domestic Japanese production. The effects of both the strengthening yen and modest growth in exports post-2008 reflect in the above graph describing Japan’s nominal GDP.

Despite the dramatic strengthening of the yen from 2000 to 2012, the Japanese overall economy managed to avoid a prolonged negative growth trend when measured in the stronger 2005 dollar, and it exhibits significant growth when measured by the significantly weaker current U.S. dollar, at about 100 yen per dollar. Should the yen continue to weaken, as it has since early 2013, you might expect Japan’s GDP to grow significantly on a yen basis, as even flat dollar-based sales mean a larger number of yen. So total U.S. consumption of Japanese goods may not grow as much when measured in stronger dollars.

As the above graph shows, the post-2012, “Abenomics”-induced yen weakness has yet to accelerate Japan’s GDP growth. Though current dollar-denominated growth in GDP seems muted since 2013, yen-denominated merchandise trade is beginning to pick up as we enter 2013, as noted in the prior graph in this series. This is great news for Japanese exporters, which have struggled for decades to enhance their competitiveness vis-à-vis China and Korea by investing in productivity-enhancing technologies—such as robotics as well as capital-intensive, high value–added manufacturing.

Is post-2012 Japanese GDP poised for growth on a weaker yen?

For China and Korea, a continued weakening of the yen could begin to erode their relatively lower cost base advantage, leading to a readjustment of the “terms of trade” between these regional economies. In other words, the relative competitiveness between the countries is driven by both the cost basis and productivity of the domestic economy, and when one currency weakens in relation to another, the resulting drop in the domestic price level can provide a competitive advantage in lowering the costs of production and enhancing export competitiveness. China has benefitted from this “terms of trade” advantage for many years, as its currency has been pegged to a fairly weak U.S. dollar. But Chinese currency has gradually appreciated against the U.S. dollar over the years. Japan has seen its terms of trade eroded for many years, as its currency has been appreciating aggressively against the U.S. dollar.

Should Japan once again double its merchandise export volumes from the current 6 trillion yen per month to a lofty 12 trillion yen per month over a six-year period, the incremental  72 trillion yen per year (approximately $700 billion USD) would approximate 12% of Japan’s current GDP. However, export growth from a weakening yen is significantly mitigated by the associated growth of imports, such as crude oil and other raw materialized used for manufacturing purposes.

As GDP measures consumption, investment, government spending, and net exports (exports minus imports), export revenue alone doesn’t make a direct, dollar-for-dollar contribution to the Japanese domestic GDP number. The offsetting cost of imports must be subtracted from the revenue of exports in determining the net effect of trade on GDP.

Regardless, this is a hypothetical increase in economic activity—with an associated multiplier effect in the local economy—would likely be a very strong positive for the Japanese economy, even if the yen value of imports should modestly outpace the yen value of exports. Regardless of gross or net export numbers, a significant increase in economic activity in Japan (brought on by a weakening currency in conjunction with new macroeconomic policy) is likely to have a significant and positive impact on the Japanese domestic economy. In fact, the near-term growth in imports over exports could also be a near-term positive for Japan, as this is likely to support or reflect the inflation-oriented policy objectives of the Abe administration, which seeks to end deflation in Japan and achieve a level of 2% inflation.

Outlook

These developments have significant implications for the future trends in Japanese equity markets in relation to its regional export competitors of China and Korea. As 2013 progresses, investors could see a continued outperformance of Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY).

While it might seem overly optimistic and simplistic to suggest that Japan can replicate its 2003–2008 export growth trajectory in the current business cycle, there are a variety of important changes in the global macro economy that could make this feat possible. We’ll explore those particular factors in further detail as we continue this series.

Continue to Part 3

  • Part 1 - Why Japanese exports could break out of a 5-year slump in 2013
  • Part 3 - Does “Abenomics” mean a new era of yen depreciation?
  • Part 4 - Why we could see a new trend in Japan’s exports and imports
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