Once feared as the high-growth export juggernaut of East Asia, Japan has been slipping in and out of deflation and recession for years. So when the government of Prime Minister Shinzo Abe recently embarked on an aggressive monetary policy aimed at ending years of deflation in the world’s third-largest economy, economists rejoiced.
To resolve Japan’s lingering economic woes, Abe has committed to pursue a “three-arrow” approach. The three arrows in his quiver are more-credible fiscal plans, aggressive monetary easing and a growth strategy based on structural reform. With Japan pledging to double its government bond holdings within two years, the Abe government is pursuing a policy of quantitative easing for as long as it takes to achieve its inflation target of 2 percent.
By early June, the yen had lost about 16 percent of its value against the dollar compared to mid-November. What impact will this have on economic growth in East Asia, and on Japanese exports to the United States?
Although the “cheap yen” may well jump-start a revival in Japan’s languishing GDP growth, “There is a risk of currency wars,” said Rob Mulligan, trade policy analyst at the United States Council for International Business. The cheap-yen policy, known in Japanese as “enyasu,” has raised widespread concerns among Japan’s trading partners that Japan is exporting deflation through a beggar-thy-neighbor push for a greater share of global trade.
“The general view is that Japan is depressing its exchange rate to get a trade advantage, not just to stimulate its economy,” said Gary Clyde Hufbauer, senior fellow at the Peterson Institute for International Economics. The cheaper yen means Japanese exports are becoming less expensive outside Japan. However, there has been no public criticism of the Japanese policy by G-8 leaders because of widespread recognition that the poor performance of Japan’s economy has contributed to the slow global recovery in recent years, Hufbauer noted.
South Korea, Taiwan and Germany will be affected the most because “they produce a similar range of sophisticated goods” as Japan, Hufbauer said. Although Chinese officials aren’t happy with “enyasu,” he noted, the strategy is less disturbing for that country because “the Chinese export pattern is very different” from Japan’s concentration on high value-added products.
How the strategy affects overall global trade will depend on how much impact the stimulus initiative has on Japan’s economic growth. Although “enyasu” will “put pressure on other countries,” if the cheap yen winds up stimulating enough Japanese growth, that could offset at least some of the negative impact of the decline of the yen on such countries as South Korea and Taiwan.
A few factors make it especially challenging for Japan to achieve its growth goals, however, Hufbauer said. First, Japan’s corporate tax burden is “quite heavy,” because the country’s Ministry of Finance “does not believe in supply-side economics” and has resisted tax reductions.
Second, a host of other Japanese governmental regulatory barriers make it harder for companies to engage in such processes as converting agricultural land into commercial real estate or widening roads in new infrastructure initiatives.
Third, energy prices are high in Japan, so Abe wants to persuade the Japanese public to re-embrace nuclear energy, two years after the Fukushima disaster soured public opinion on nuclear power. Overall, “It will be a big achievement if Japan grows at 2 percent, and 3 percent growth would be truly amazing,” Hufbauer said.
If Japan doesn’t follow up the stimulatory measures of “Abenomics” by undertaking structural reforms and dismantling long-standing regulatory and other non-tariff barriers to imports, Mulligan isn’t sure the impetus Japan derives from the stimulus program will last. After all, “It is still hard for American companies to penetrate their markets because of non-tariff barriers,” he said.
If Japan’s growth rate rises significantly, it likely will pull more imports from the U.S. into Japan, Hufbauer said. But if the yen becomes too weak, it could cause significant damage to some U.S. manufacturers, particularly in the automotive sector. “U.S. auto firms are angry about Abenomics,” he said, because they fear Japanese automakers will leverage the yen’s decline to lower their prices — and increase their sales in the U.S., depriving GM, Ford and Chrysler of domestic market share.
Japanese automobile exporters also could simply increase their margins in the U.S. — while making minimal price cuts there — but reap greater profits that they later invest in the U.S. to improve their products and competitiveness.
Other observers see potential for a much more disturbing global economic scenario. The falling yen, coupled with a decline in foreign investment inflows into Japan, “increasingly resembles” the run-up to the 1997 currency crisis, according to Albert Edwards, a strategist at Societe Generale. “It seems investors may have forgotten that yen weakness was one of the immediate causes of the 1997 Asian currency crisis and Asia’s subsequent economic collapse,” Edwards wrote in a global strategy advisory.
After meeting with clients in Hong Kong and Singapore, Edwards forecast the Bank of Japan will lose control of its new program of aggressive monetary easing, leading to spiraling inflation and an increasingly unsustainable debt position.
Stephanie Kretz, a researcher at Swiss investment bank LombardOdier, said the falling yen looks like a replay of the mid-1990s before the onset of the East Asian crisis, when external funding dried up in a “sudden stop.” Other Asian countries “will see their own currencies appreciate,” which is “all the more unavoidable since several constraints may prevent them from taking steps toward weakening their currency,” she said. The direct consequence of a weaker yen, Kretz said, will be a loss of competitiveness and slower export growth for those Asian countries.
That will translate into slower growth throughout the region. East Asia is particularly vulnerable because the total exports of six of the region’s 11 countries represent more than half of their national GDP (92 percent in Malaysia, 87 percent in Vietnam and 77 percent in Thailand). For three other countries — China, Laos and the Philippines — exports represent a third of their GDP, and for the final two countries — Singapore and Indonesia — exports amount to one quarter.
As they slide into current account deficits, these countries will need to resort to foreign financing to service generally high debt levels. Private sector debt in Hong Kong is similar to that of Spain and Ireland, and above that of Portugal. China’s and Thailand’s debt ratios surpass Italy’s. Given East Asia’s higher reliance on exports, the weakening yen can only have negative consequences for these economies, Kretz said. It may even plant the seeds for the next Asian crisis.
All of these concerns are emerging within the context of talks for the ambitious Trans-Pacific Partnership, which would bring nearly a dozen nations together in a trade bloc whose scope would encompass not just further tariff reductions, but comprehensive cuts in the sorts of regulatory and non-tariff barriers that have made Japan so challenging for many foreign traders and investors.
At the 17th round of TPP negotiations in Lima, Peru, in May, the 11 current TPP countries discussed plans for “smoothly integrating Japan into the TPP negotiations,” according to the U.S. Trade Representative’s Office. Japan will join the negotiations following the successful completion of current members’ respective domestic processes.
“If the Japanese can engage in meaningful negotiations with the 11 (other) countries involved in the TPP talks, this will give them better access” to those countries, Mulligan said.
Moreover, the scope of the TPP would build over time, with China looking at the TPP and thinking about joining the talks. “This is a significant area, especially if you add in Mexico and Canada,” Mulligan said. South Korea and Indonesia also are looking at it. “This is an opportunity that the Japanese can take advantage of.”
With Japan’s entry, TPP countries would account for nearly 40 percent of global GDP and about one-third of all world trade. It remains to be seen whether the TPP will incorporate any commitments on the part of member states not to engage in unfair manipulation of their currencies.
Contact Alan M. Field at email@example.com.