“Success consists of going from failure to failure without loss of enthusiasm.”
Commentary & Analysis
Will Japan Succeed?
- Japan’s success is far from certain; it is a catch-22
- If success is predicated on a rising current account surplus, it could spark turmoil elsewhere
- Global turmoil likely means another safe-haven flow back to the yen
As you know, I am big fan of Professor Michael Pettis; he of Beijing University fame. He is an expert on global macro and often shares many out-of-the-box insights. Mr. Pettis seems very concerned about Prime Minister Abe’s chances for success. The odds of failure appear high. Let’s take a look at a few key points.
The global macro current account stuff is a bag of worms. But keep in mind the word “balance.” Flows at the macro global level tend to balance, so if there is a big surplus recorded by a large country somewhere then there is an equal deficit (or lower surplus) being recorded someplace else.
Now, when we line up the major countries, in terms of their current account balances, we have the big four:
- United States Deficit = $98.9 bn
- Japan Deficit = $1.2 bn
- China Surplus = $193.1 bn
- Germany Surplus = $238.5 bn
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Here’s the rub as it relates to Japan’s strategy for success under Prime Minister Abe: Japan’s current account surplus will likely have to rise dramatically, according to Mr. Pettis—this has many global implications…
- China and Germany need strong current account surplus numbers in order to keep all the balls in the air. And don’t think the US is happy with its current account deficit in a time of still tepid global demand (though this might be countered with the latest trade report that shows US exports hit a record and China bought more).
China is working hard to reduce credit growth, especially in its shadow banking system, but to do so in a way that doesn’t cause a financial accident. The country can hardly afford to lose export share to Japan (which it is in jeopardy of doing as Japanese multinationals become more aggressive and the yen weakens relative to the Chinese yuan. [The yuan has appreciated about 38% against the Japanese yen since September of last year.]
Could this have something to do with China’s recent aggressive tactics in the East China Sea? A great piece of research on this topic by the Council on Foreign Relations...
2. Germany’s dominance of the Eurozone is clear. But Germany’s ongoing strategy is increased share of its trade going to the emerging markets of the world may come under severe pressure. Japan is after the same share. And as Japan continues to dole out large sums in foreign aid to those countries that happen to be near and afraid of China, and confidence returns to Japanese multinationals, it might be fair to say Japanese companies will be very strong in those same markets German companies are competing for.
3. If Japan’s current account improves, it may not be good for the US and could lead us back to where we just came—more consumer debt. As Mr. Pettis puts it: “The US for example has to worry that policies aimed at increasing domestic demand don’t simply result in rising debt as US demand bleeds out through the current account sector.” US officials are all for a strengthening Japan. At the very least as it creates a stronger buffer to Chinese expansion, but also as a strong Japan is expected to strengthen the global financial system—it of course depends on where Japan’s strength flows from.
It seems clear Japan needs to improve domestic productivity and drive growth from more consumption—normalize its economy if you will. But interestingly, the big relative devaluation of the Japanese yen is a tax on consumption. Thus, Japan’s saving rate is forced up relative to investment (and local investment is needed to drive real productive gains inside the country, instead of falling back on the standard Asian export-model). But there is a method to this madness because as Japan’s internal saving rate increases, it means Japan can live with its massive debt burden (200%+ debt/gdp) given that most is internally funded.
But diabolically, if the domestic economy is sparked and inflation ensues and market rates rise, this adds a dangerous new debt concern.
Talk about a catch-22.
It is of course expected even if Japan’s domestic economy grows faster, rates will remain suppressed thanks to the Bank of Japan largess. That is a recipe for continued financial repression against Japanese depositors/consumers and thus hampers domestic growth going forward.
Mr. Abe and Japan and the global economy are still walking a tight rope. Unlike in 2008, the rope isn’t suspended 200-feet off the ground over top a moat of hungry crocks. But if Japan succeeds in weakening the yen more and driving its current accounts surplus higher and aggregate global demand remains weak or one of China’s fighter pilots let’s one of his missiles slip out into a Japanese fighter jet, those hungry crocks will be back. And then the specter of a major debt crisis in Japan is front and center once again. Uhggg….
So maybe this is all part of the “new normal.” Very slow incremental reform in order to buy time for healing. No wonder so many believe QE will never end.
But if I am thinking about Japan’s success at the moment, you can bet a lot of people with a lot more brains and money than I have are thinking similar thoughts. So maybe it’s not a bad time to consider leaning a bit against the one-way bet short the yen…maybe?
Black Swan Capital