"Abenomics": A bull market for Japan's consumers? (Part 4 of 5)
Japan’s personal consumption
The below graph reflects Japan’s progress toward becoming a U.S.-style consumer-driven economy. While the 2008 financial crisis slowed the growth of consumption in Japan, consumption as a percentage of Japan’s GDP—gross domestic product—has recovered. It’s significantly higher than a decade ago, at just over 61% of GDP. Despite a lack of both real GDP and real disposable income growth since 2005, Japan has managed to grow the consumption portion of its overall economy. As Prime Minister Abe’s policies take effect, will we see a further increase in consumption as a portion of Japan’s overall economy?
Larger budget deficits and aggressive monetary policy
As noted in the first part of a previous series, Japan’s new Prime Minister, Shinzo Abe, in conjunction with Bank of Japan Governor Haruhiko Kuroda, will attempt to end the post-1990 deflationary spiral that has gripped the Japanese economy. These policies, known as “Abenomics,” will attempt to encourage private investment through a more aggressive mix of monetary and fiscal policy. “Abenomics” aims to end deflation by targeting a 2% rate of inflation, as well as to increase fiscal spending by 2% of GDP. This level of government spending is expected raise the 2013 deficit to a whopping 11.5% of GDP in 2013—higher than that of the U.S. budget deficit after the 2008 crisis as well as present-day Greece (with approximately 10.0% budget deficits).
“Abenomics” and “Reaganomics”
While both Ronald Reagan and Japan’s new Prime Minister were both elected with mandates to fix the economy, the economic particulars couldn’t have been more different. As we saw in a related series on U.S. consumption, Part 5 of U.S. consumer spending: Sustaining the unsustainable?, Ronald Reagan had supported Paul Volcker to head the U.S. Federal Reserve Bank (Fed) in order to slay inflation, while Prime Minister Abe has supported Haruhiko Kuroda to head the Bank of Japan to slay deflation. Volker achieved his goals by raising short-term interest rates to a record high of 20%. In contrast to Volker, Kuroda’s $75-per-month bond buying operations had pushed the ten-year yield on Japanese bonds from 1% to a record-low 0.43% in April this year.
As we saw in Part 2 of U.S. consumer spending: Sustaining the unsustainable?, the U.S. Personal Consumption Expenditure (U.S. PCE) is approximately 70% of GDP. When Ronald Reagan took office in 1981, U.S. PCE as a percentage of GDP was at approximately 61%, much like Japan today. When Reagan left office in 1989, this number reached 64%. You could argue that the supply-side policies of Ronald Reagan started the trend toward consumerism in the United States, and that George W. Bush reapplied them after the dotcom and 911 crises in the form of the Bush Tax Cuts, as we described in Part 4 of the U.S. consumption series.
Supply versus demand: Is “Abenomics” the mirror image of “Reaganomics”?
While “Reaganomics,” like the Bush Tax Cuts, sought to stimulate the demand side of the U.S. economy through focusing on supply via tax cuts, the big difference between “Reaganomics” and “Abenomics” is the aspect of demand. “Abenomics” also involves (small) corporate tax cuts, though it phases in large consumption taxes. You might expect “Abenomics” tax policy to potentially constrain demand, as taxation would simply increase, on net. But in stark contrast to the Reagan and Volker agenda, Abe aims to increase inflation—not decrease inflation—the mirror image or opposite.
So, if Abe and Kuroda can convince the average Japanese consumer that everything will cost more in the future because inflation is on the way, and that they’ll be paying larger and larger consumption taxes in the future, then the Japanese consumer will have a much stronger incentive to increase consumption today over consumption in the future. So we can see that the demand stimulation aspect of “Abenomics,” based on rising inflation expectations, may be a much larger driver of consumption and economic growth than the supply factor, involving relatively small corporate tax cuts combined with ongoing increases in future consumption taxes.
In other words, “Abenomics” seeks to address Japan’s shortage of demand vis-à-vis supply by growing inflation, while “Reaganomics” sought to address an apparent shortage of supply vis-à-vis demand by shrinking inflation. While these approaches are somewhat opposite, this is because the economies embody the opposite problems. However, if “Abenomics” works through stimulating demand and consumption via credible inflationary scare tactics, this could lead to a significant increase in Japan’s personal consumption relative to GDP, as the above graph reflects.
So it’s possible that Abe and Kuroda, like Reagan and Volker in the United States, will usher in a new phase of consumerism in Japan, with consumer credit in Japan rising from the current 5% of GDP toward 18%, like the United States. Japan has a long way to go in this regard, and we would need to see significant changes in both wage growth and expected future wage growth before Japanese consumers apply for more credit cards. However, stoking inflation is a step in that direction, and as they say in Japan, “Even a journey of a thousand miles begins with one step” (Senri-mo, iippo-kara). Good luck, Mr. Abe (Gambatte, Abe-san)!
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). For further clarification as to why DXJ could outperform both EWJ and other Asian equity indices, please see Why Japanese ETFs outperform Chinese and Korean ETFs on “Abenomics”. Plus, as Japan pursues unprecedented monetary expansion, and the U.S. Fed ponders monetary tightening, Japanese equities could 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 further analysis of how China is being affected by Japan and “Abenomics,” please see China’s exports: Is the Golden Age of Cheap Labor Coming to an End? For further analysis of how United States–related consumption trends could impact Japan’s ”Abenomics”-led recovery, please see U.S. consumer spending: Sustaining the unsustainable? For further analysis of how exports in Japan are being affected by “Abenomics,” please see Japanese exports: Are we seeing an “Abenomics”-led recovery in Japan?”
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