For GM, which is worse—the recall or a weakening yen? (Part 2 of 12)
A weakening yen: export growth for Toyota offsets energy cost gains
The below graph reflects the ongoing growth in Japanese vehicle exports as well as growth in crude oil imports. As Japan imports over 40% of its energy needs, Japan feels significant economic pressure from purchasing oil. In the short term, this trend can cool consumption of Japan’s domestic demand for autos. Although in the longer run, the weakening yen supports price competition of Toyota (TM) versus General Motors (GM). The below graph reflects the growth in purchasing oil in Japanese yen.
Remember that the Japanese yen has weakened approximately 30% against the dollar and Euro since 2013—and even more against the Chinese yuan. This weakening in the domestic currency means Japan has had to spend much more on importing oil. As noted later in this series, this development has lead to an immediate impact on Japan’s development of an ongoing trade deficit since 2012 as well. This trade deficit reinforces the yen weakening, which may also reinforce Japanese automakers’ exports and profits in the long run. This article considers the inter-temporal cost/benefit of importing oil with a weakening currency versus exporting merchandise such as vehicles. On an average, these developments should be positive for Japanese auto exporters in the long run, and put pressure on its U.S. competitors like GM.
Why the weak yen helps Toyota—GM’s main auto competitor—the most
Toyota has the most onshore, Japan-based production—standing at 40% of production, which is down from 50% in 2007. Honda’s domestic production is at 26%, down from 34% in 2007. Nissan now only produces 20% in Japan, and has pursued low-cost production in Thailand and South Korea. Japan still tends to keep core production at home—engine blocks, crank shafts, and other items that require higher levels of engineering and precision in manufacturing. While companies like Nissan and others pursue low-cost manufacturing bases overseas, Japan’s weakening yen may revive Japan’s domestic production in the future. Toyota stands to benefit the most from this potential trend of the weakening yen.
Oil problem is Japan automakers’ blessing
As Japan’s currency has weakened drastically since 2013, this has meant different parts of the economy have felt different impacts. For Japan as a whole, more expensive oil is like a tax that is born by all consumers of imports—especially oil/power. However, for exporters, such as Japanese automakers, this development is typically a blessing, as the overall domestic costs base declines. As the above graph reflects, the yen-based level of Japanese auto exports has grown significantly since 2012. This reflects a weakening currency. The growth in Japan’s trade deficit pertaining to crude oil and China-manufactured items reinforces the yen weakness, and supports Toyota’s domestic production competitiveness in the long run, although a softening domestic demand in the near term is possible.
Japan’s near-term oil shock—not so shocking
In the near term, the Japanese economy as a whole will feel the bite of more expensive oil—just as the U.S. did when it experienced the oil crisis of 1973. For the U.S., the rising price of oil in dollars led to significant domestic inflation. In 1973 and 1974, the cost of oil went from $3 per barrel to $12. With gas costing the U.S. consumer around 4% of their disposable personal income these days, we can see that a 400% increase in the price of gas is a significant impact. Japan will not be facing anywhere near this level of oil-related inflationary pressure, but is facing some trouble, as reflected in the above graph.
Japan’s monetary shock therapy—great for Toyota, bad for GM
For Japan, the oil-related burden due to a weakening currency is a short-term negative in terms of its tax-like impact on the broader economy. However, as Japan has been trying to end deflation in the economy, the oil-driven trade deficit will provide additional inflationary support to the current aggressive monetary policy. The Bank of Japan currently holds around 2. 2 trillion yen in assets, and may grow this level to $2.7 trillion by the end of next year. That level of asset purchases of the Central Bank of Japan equates to roughly 50% of Japan’s gross domestic product, in comparison to the U.S. Federal Reserve’s reflationary purchases, which rose to around 25% of the U.S. GDP.
Near-term negative, long-term positive
In the near term, Japan will experience economic pressure on more expensive oil imports. However, should the Japanese yen continue to weaken over time, eventually, this will mean more robust export growth and profits for Japanese exporters—and more competition for the recovered “New GM.” Note that the impact of currency-related crude prices is swift and immediate, while gearing up the manufacturing base for growth could take time and planning.
Given that Japan has worked off much of its production capacity overhang since 2008, trade-related growth for Japan would likely involve more investment, and this would support economic growth and consumption in Japan in the future. The near-term GDP data could get ugly in Japan, though the long-run effects of a weaker currency should be positive, and Japanese automakers will likely be large beneficiaries of this long-term change in the weakening currency. Should things eventually evolve in this direction, the U.S. automakers can face greater price competition from Japanese exporters.
Japan’s equity outlook
As 2014 progresses, investors may 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). For further clarification as to why DXJ may outperform both EWJ and the other Asian equity indices, read Why Japanese ETF’s outperform Chinese and Korean ETF’s on Abenomics. Plus, as Japan pursues unprecedented monetary expansion, and the U.S. Fed tapers its bond purchases, Japanese equities can also outperform broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV).
For more on how the U.S. Fed’s recent announcements could impact global equities, read Will the Fed take a bite out of Apple?
To see how Japan’s trade is developing with China, the USA and the EU, please see the next article.
Browse this series on Market Realist:
- Part 1 - Will the GM recall turn out to be worse than Toyota’s recalls?
- Part 3 - Japan’s trade deficit with China: Worse for GM than the recall
- Part 4 - GM’s long-term competitive threat: Japan’s investment recovery
- Japanese yen