Most observers of central banking in general – and Japanese economics in particular – are excited at the prospect that newly-elected Japanese Prime Minister Shinzō Abe brings to his post.
Abe has been very vocal about pumping fiscal stimulus into the economy in a bid to end Japan's decades-long struggle against deflation. He's also threatened to turn central banking upside down by stripping the Bank of Japan of its independence and revamping its mandate – an unprecedented move in the modern world.
There is a good argument to be made that Abe is really just bluffing about the BoJ and pursuing more radical monetary policy. His background as a politician who has fought his whole career to move Japan to the right on social issues suggests that perhaps he is just talking down the yen, so to speak, just long enough to be able to shift his focus back to implementing the controversial social policies he seems to care so much about.
Regardless of Abe's true intentions, though, the yen has, in fact, weakened dramatically since September:
The argument goes that part of the magic of the yen's decline is a boost in competitiveness for Japan's big exporters – globally recognized brands in automotive and tech like Toyota, Honda, Sony, and the like. This, in turn, could finally get the moribund Japanese economy going and ultimately stoke a little inflation.
However, Mitsubishi UFJ Morgan Stanley Chief Economist Nobuyuki Saji argues that those potential gains are overstated, and a much worse fate could belie the Japanese economy if the yen continues to weaken.
In a note to clients entitled " Weaker yen could make Japan a nation of poor seniors," Saji writes:
The fact that Japan has a trade deficit in everyday necessities means that a weaker yen will reduce the household sector’s real income. At the risk of exaggeration, we could say that depending on how far the yen depreciates, Japan could slip to the level of an impoverished country by becoming a poor importer. Let us look back on Japan’s trade deficit in food, now about ¥5.3trn, and how it has changed due to food import prices and the ¥/$ rate over the past 15 years.
There have been three yen-weakening phases since 1990. The first lasted from May 1995 to July 1998 and took the exchange rate from ¥83.2/$ to ¥143.7/$, which marked yen depreciation of 72.7%. The second lasted from December 1999 to February 2002 and saw the yen depreciate by 31.0%. The third lasted from November 2004 to June 2007 and saw the yen depreciate by 19.4%. Over these three phases, the yen-based import price of food rose by 28.1%, 19.0%, and 35.3%, respectively.
Therefore, the rates at which importers were able to pass on higher costs in their selling prices were 38.6%, 61.1%, and 181.8%, respectively (change in import prices / change in yen’s value).
The third yen-weakening phase occurred when the Chinese economy was very active (annualized GDP growth of 12.7%), causing grain prices to shoot up. Nevertheless, in the period since 1990, which largely overlaps with the peak-out (1992) and decline of Japan’s economically productive age group, importers have been able to pass on an increasing proportion of forex-related price increases to their customers. This can only be because the production capacity of domestic companies making competing products has declined.
Incidentally, in the yen-strengthening phase since June 2007, the yen has appreciated 35.4% while food import prices have declined by only a slight 5.0%. What about other everyday necessities such as textiles (clothing, etc.)? Since 1990, the rates at which importers have passed on forex-related price increases in yen-weakening phases have been 43.9%, 12.0%, and 62.5%, respectively.
In the yen-strengthening phase since June 2007, textile prices have risen 0.2% even as the yen has strengthened by 35.4%. As with food, textile prices tend to rise in yen-weakening phases, but they resist decline in yen-strengthening phases. This is evident from 15 years of data.
To sum all of that up, big downward moves in the value of the yen typically mean that Japanese consumers – increasingly comprised of aging seniors – pay up quite a bit more for food than they did before.
Making matters worse is Japan's ballooning trade deficit in food – the Japanese are increasingly reliant on imports to feed themselves, making the declining value of the yen even more significant.
We do not deny that a weaker yen would be positive for the earnings of Japanese companies, but in macroeconomic terms a weaker yen does not have the same export-boosting power that it used to.
Instead, we must not overlook the fact that a weaker yen will raise the prices of everyday necessities and thus lower the real incomes of the Japanese people. Even as Japanese society ages, there is a limit to how much people can cut back on consumption of goods where import dependence is high, such as food, clothing, and energy.
We cannot rule out the possibility that the household savings rate will turn negative. Japan’s ballooning fiscal deficit is starting to show signs of becoming unmanageable (rapidly rising national debt). The possibility is rising that trade deficits and current account deficits will become entrenched as the norm.
If Japan is starting to face triple deficits, it means the United States and Japan have traded places and the weaker has become the stronger over the past 30 years. If Japan falls into triple deficits, we will have to prepare for drastic yen depreciation. Incidentally, the exchange rate we calculate based on PPP in manufactured products is ¥83/$, while the exchange rate we calculate based on PPP for the basket of CPI goods is ¥125/$ (comparing US and Japanese prices).
That last bit about purchasing power parity is telling. When Saji calculates the dollar-yen exchange rate based on manufactured products – the domain of large Japanese exporters – it's very close to the official rate, which currently stands at ¥ 87.90 per dollar.
However, the yen buys considerably less when looking at goods in the consumer price index basket – which is much more heavily weighted toward items like food, energy, and clothing.
Abe would love it if those two exchange rates calculated by Saji were switched – but they're not. Weakening the yen in a bid to boost exports is a flawed strategy from the get-go, a remnant of the legacies of former Japanese prime ministers, including Abe's grandfather himself.
In the process, Abe could end up leaving the Japanese economy in a much more dangerous position than before.
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