Japan, despite its size, is a major economic heavyweight and the world's third largest economy, boasting a Gross Domestic Product (GDP) worth 4.9 trillion US dollars. That is approximately 8 percent of the value of the world economy, according to 2013 figures. But oddly, when Japan puts out negative economic data, economists these days no longer bat an eye lid, it is expected.
But why? What’s happened to the Japanese Prime Minister Shinzo Abe's grand economic policy, dubbed by the media as "Abenomics"? It was intended to revive the sluggish economy with “three arrows”: A massive fiscal stimulus, more aggressive monetary easing from the Bank of Japan, and structural reforms to boost Japan's competitiveness.
Abenomics had a predictable impact on the financial markets. Increasing the money supply, or pumping the monetary system with liquidity did pull interest rates lower, which intern depreciated the Japanese Yen as speculative money, also known as “hot money”, flowed out of the Yen into other currencies offering more favourable rates of return. Technically, the demand curve for the Japanese Yen shifted to the left and its price (exchange value) fell, so the basic economic theory goes.
That is pretty much what happened. The Yen became about 25 percent lower against the US dollar in the second quarter of 2013 compared to the same period in 2012. This trend, a falling Yen against the US dollar, continued as I forecast in my last piece on Japan.
So aggressive monetary easing, lower interest rates and a depreciating Yen should make Japanese exports more competitive abroad, thereby stimulating exports. Has that happened?
Yes, but the jury is still out whether the momentum in export growth can continue going forward. Japanese exports are set to rise for a second straight month in October but at a slower pace than the previous month.
“Reuters poll showed, placing a doubt over whether the weak yen has brought about a full-fledged recovery in export growth. Exports are expected to have risen 4.5 percent in October from a year ago, the poll of 21 economists showed, after a 6.9 percent increase in September.”
But a depreciated Yen also does something else when Japanese companies abroad repatriate their capital back to Yen, it makes these multi-national companies look more profitable.
By May 2013, fueled by loose monetary policy, the Japanese stock market had risen by 55 percent and consumer spending recovered for a period. A Nihon Keizai Shimbun survey found that 74% of the respondents praised the policy in alleviating Japan from the prolonged recession.
However, workers didn't see any increases in their wages, in a recent survey only 28 percent of workers were expecting an increase in their pay. Additionally, the depreciation in the Yen had resulted in imports becoming more expensive, particularly in food, oil and other natural resources upon which Japan is highly reliant.
But the recent third quarter GDP data from Japan showing an annualised 1.6 percent in July-September contraction is now confirmation that Japan is in a recession.
So economic growth is currently in decline, exports are losing momentum, along with the stock market and the trade deficit is still widening. Maybe the only positive sign is that deflation is moving into inflation.
So what has happened to the Abe's three arrows.
Arrow one, aggressive monetary stimulus, widely missed its target.
Consumers and small businesses have lost out as import prices have risen, especially for energy reducing real wages, which have fallen by 5% over the past seven years. Big companies have been reluctant to give pay rises to workers, even though they are flush with accumulated profits.
Moreover, labours share of the national pie has dwindled from 66 percent to 60 percent in the last 10 years. So with workers sharing less of the national income and falling real wages it is no surprise that consumer demand is weak.
Japanese multi nationals are more interested in developing export markets in the emerging economies of the pacific and Asia, such as Indonesia, India, Myanmar and the Philippines. So pumping the system with liquidity has failed to increase domestic private investment and consumption.
The second arrow, fiscal stimulus, broke in mid-flight. The revolving door between politicians and industry resulted in spending public money on white elephant infrastructure projects. A few, with close ties to government filled their pockets at the expense of the taxpayers.
The third arrow, structural reform, also went astray. The recent corporate governance scandals testify to close links between Japanese business and the mafia (Yakuza), “Japanese business is run like an old boys club, with no culture of transparency, openness and accountability.”
But having said all that, there might be an opportunity for investors/traders, albeit a short term one. It's a classic Rothschild strategy, “Treat the stock exchange like a cold shower (quick in, quick out)."
It might play out something like this; the disappointing Q3 GDP figure has pushed the Japanese government to call an election. Usually the government spin doctors release all the bad news just before a government calls an election, then during the campaigning months when the government is touting for votes, the economic data tends to be rosy and markets rise.
If that is the case, then we are likely to see a reversal in trends, a rising Japanese Yen and the Nikkei Index in the months leading up to the general election in Japan.
In other words, a short term bull run in equities and the Yen, in a secular bear market provided that no black swan events occur (unforeseen events like a natural disaster, war)
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