On the Failure of Abenomics

In a period when all politicians are either dull or unwilling to break away from routine – “tradition,” when it seems that in every Western nation the spring of imagination is dried up; Mussolini gives the impression of an ever-welling source. One may object to any form of dictatorship, but one cannot help being stimulated by the phenomenal vitality of this man who, in his role of dictator, has commanded the barren soil of Italy to produce wheat within a given time; ordered his territory to be expanded (by reclaiming swamps) without extending his frontiers; and, not content with summoning new cities into existence, is changing the face of the Eternal City by digging up the buried glories of Imperial Rome.

Valentine Thomson, NYT, 1933

 

In a sense, the really remarkable thing about “Abenomics” — the sharp turn toward monetary and fiscal stimulus adopted by the government of Prime Minster Shinzo Abe — is that nobody else in the advanced world is trying anything similar. In fact, the Western world seems overtaken by economic defeatism…the overall verdict on Japan’s effort to turn its economy around is so far, so good. And let’s hope that this verdict both stands and strengthens over time. For if Abenomics works, it will serve a dual purpose, giving Japan itself a much-needed boost and the rest of us an even more-needed antidote to policy lethargy.

As I said at the beginning, at this point the Western world has seemingly succumbed to a severe case of economic defeatism; we’re not even trying to solve our problems. That needs to change — and maybe, just maybe, Japan can be the instrument of that change.

Paul Krugman, NYT, 2013

 

 

 

Right off the bat, I would like to quash the notion, borne from lazy reasoning, that I am comparing Shinzo Abe to Benito Mussolini. What I’m doing is highlighting the fact that it is extraordinarily popular to believe that, in the face of crisis (particularly an economic one), some sort of supreme, bold, decisive action is required from those in leadership positions, to the extent that any action, no matter how dubious in nature, is to be applauded merely because it is perceived as bold. In 1933, during the depths of the Great Depression, the likes of Mussolini stood out on the global stage as purveyor of such bold and decisive actions, which were lauded in the NYT article I quoted, among others of the period, because the end results were positive. You could take issue with the tactics involved, but who could argue with the idea that wheat springing from the barren fields of Italy was bad thing?

Eighty years on, the majority of the economic establishment similarly extolled the virtues of Shinzo Abe and his economic doctrine, known as “Abenomics.” This economic plan was comprised of three prongs, or ‘arrows’: Fiscal stimulus, monetary stimulus, and structural reform. On its face, this initiative is bog standard policy talk. The boldness comes from the nature of its goals, and the stated commitments to those goals given by Abe and the Bank of Japan. In implementing Abenomics, they’ve made it clear that they will not stop until they reach their stated metrics – regardless of how much money gets printed or how much debt must be undertaken. It is this attitude that many have praised as being bold.

The necessity of such a bold doctrine, the story goes, is that Japan has been mired in 20 years of deflation which has ruined their economy. The following is a longer term chart of Japan’s CPI.

japcpi

Quite clearly, Japan has not had 20 years of deflation, or anything close to that. What Japan has had are periods when prices have gone up slightly, followed by periods when prices have gone down slightly. In other words, they have had ‘price stability.’ As in the actual definition of price stability, rather than the changed definition which Keynesian influenced economists have put forth over the last decade. Recall that deflation, even if it is as little as a 0.1% drop in prices is the worst possible thing that could happen to an economy, the narrative goes. The threshold for disaster has even risen, with respect to prices, such that an inflation rate of under 2% is the new line in the sand, as per the concerns over ‘lowflation’ expressed through much of 2014.

Given that, how is it possible to maintain ‘price stability,’ (which virtually every central bank claims it wants) when the prevailing economic dogma declares that one of the forces enabling such stability, falling prices, is worse than cancer? You change the definition of ‘stable’ to mean ‘rising at least 2% per year.’

But I digress. The fact is that Japan had achieved price stability. As this not consistent constant inflation every year, the mainstream economic establishment sees a gigantic problem, and thus never tires of telling us how Japan is basically an economic wasteland, despite actually being one of the most highly developed countries on earth.

Thus, the ‘need’ for bold action was apparent, and Abe answered the call, instituting a weak yen policy and fiscal stimulus. The rise in inflation over the last 18 months, as shown in the chart above, was universally celebrated as the first major step in the Japanese recovery story. The reality is that it is merely the first step on the path to nowhere.

Generally speaking, currency depreciation and fiscal stimulus are the go to methods for dealing with crises. As such there is plenty of historical evidence to suggest that this course of action is not a successful one. Writing on the problems with currency devaluation as a vehicle to success, Mises wrote the following, in Human Action:

The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption.

Indeed, one of the main selling points of Abenomics, apart from the pledge to defeat deflation, was the idea that Japan was going to export its way to prosperity, with a weaker yen as its catalyst. From late 2012 to the present, the USD/JPY has gone from 80 to 120, the higher figure indicating yen weakness against the US dollar. The effect of this on exporters and large manufacturers has been mixed, at best.

Although there are quite a few recent articles highlighting the resurgence of ‘Japan Inc.,’ nearly all of them highlight the basic problems with currency devaluation as an economic growth strategy – namely the temporary nature of any gains. In weakening the currency, exporters see their products become more attractive to customers, boosting sales. The problem is that over time, the same weak currency affects future production by increasing input costs in terms of the reduced currency. This is true for any actor which operates in the domestic market – increased costs are going to be detrimental to future production. Any gains by exporters seen from increased sales overseas are ultimately eroded in this manner.

This is the gist of the tempered enthusiasm seen in many of the articles praising Japanese growth. From Bloomberg:

Japanese companies are headed toward their highest profits ever, as the falling yen boosts exporters from Toyota Motor Corp. (7203) to Uniqlo-operator Fast Retailing Co. (9983)

Aggregate net income at 195 of the largest listed companies will expand 10 percent to a record 17.5 trillion yen ($153 billion) this fiscal year, based on analyst estimates compiled by Bloomberg. Executives are catching up to such lofty expectations, with Toyota this week raising its profit forecast to an unprecedented 2 trillion yen.

….

Still, Japanese companies that mainly rely on local demand are unlikely to benefit from the yen’s decline.

For example, NTT DoCoMo Inc. (9437), the country’s mobile-phone operator, cut its net income forecast to 420 billion yen from a previous projection of 480 billion yen.

McDonald’s Corp. (MCD)’s Japan business, which relies on imported ingredients to make its burgers, said yesterday that the weaker Japanese currency will hurt its business. The burger make said profit is reduced by about 100 million yen every time the exchange rate drops by 1 yen against the dollar.

 

The Financial Times:

Manufacturers see sales rise when dollar-denominated exports are converted to yen. Costs also fall if they are billed in yen, and income from affiliates and overseas subsidiaries increases in yen terms. Analysts say that, as long as the decline in the yen is orderly, it could go to 130 or even 140 against the dollar before rising costs erase all advantages.

According to estimates last month from Mizuho Bank’s industry research division, a fall in the yen from 105 to 115 against the US dollar would lift listed companies’ operating profits by about Y1.9tn – roughly 7 per cent of the total in the past fiscal year – but would cut unlisted companies’ operating profits by about Y1.3tn, for a net gain of about Y650bn.

But those benefits are unevenly distributed. Smaller companies, for example, have thinner margins to absorb rises in input costs, and many are buckling under the strain. Between January and September there were 214 cases of bankruptcies related to the weaker yen, according to Tokyo Shoko Research, about 2.4 times the total for the same period a year earlier.

The government has responded with a package of support measures, including relaxing its own procurement rules to allow state agencies to buy from companies less than 10 years old.

Even among Japan’s high-profile exporters, there are losers on the currency. At Sony, for example, which generates three-quarters of its sales overseas, a lower yen is good news for the image sensor and digital camera segments. But gains are offset by the smartphone and game divisions, which procure components from abroad and pay suppliers in the US currency. As a result, the group says, every Y1 fall against the dollar drains Y3bn of operating profit.

 

The ultimate result of currency devaluation is that a select few, mostly large manufacturers and exporters, benefit for a very short time, while everyone else who is subject to the currency suffers.

The weak yen is responsible for increased sales to manufacturers and producers, and also for the recent increase in inflation (refer to the above chart). This means that the weak yen is also responsible for the decreases in purchasing power shown in the following chart.

japan wages

Both nominal and real wages have gone over a cliff in the latter half of 2014, which is to be expected. With respect to production, as input costs rise, it means that firms will engage in cost cutting measures to preserve profit margins. The price of raw materials rising thanks to a weak yen is out of the control of a manufacturer. However, nominal wage freezes, nominal wage reductions or even layoffs are well within the control of manufacturers and they will explore these avenues to stem the tide of rising costs elsewhere.

From a real wage standpoint, the fact that nominal wages are falling or flat, combined with the prices of goods and services rising as per dictum of Abe and Karoda, creates a situation in which average Japanese workers are seeing their economic positions weaken. A poorer consumer cannot spend as much, which is why retail sales have been tepid:

japsales

The ultimate result of which is the return of Japan into recession, which officially happened in the last quarter:

japgdp

This week, the failure was further crystallized as news came that the Japanese saver is saving no more. From Bloomberg:

Japanese drew down savings for the first time on record while wages adjusted for inflation dropped the most in almost five years, highlighting challenges for Prime Minister Shinzo Abe as he tries to revive the world’s third-largest economy.

The savings rate in the year through March was minus 1.3 percent, the first negative reading in data back to 1955, the Cabinet Office said. Real earnings fell 4.3 percent in November from a year earlier, a 17th straight decline and the steepest tumble since December 2009, the labor ministry said today.

A higher sales tax combined with the central bank’s record easing are driving up living costs, squeezing household budgets and damping consumption. Abe’s task is to convince companies to agree to higher wages in next spring’s labor talks to sustain a recovery.

The bottom line is that real recoveries are impossible when the strategy employed reduces the purchasing power of those who would sustain it. And to date, the only strategy employed by policy makers have been those which only result in reduction of purchasing power of average workers. There has been much consternation over the increased sales tax which took place earlier in the year, which was only a part of the planned increase. According to some, the only reason Abenomics isn’t having the desired effects is because of the tax.

Tax increase  or not, the weak yen which was a staple of the policy still would have increased costs of production for manufacturers and increased the cost of living for consumers, ultimately crippling the spending capacity of each group. The bemoaning of the heightened tax is also ironic given it is now coming from the same group of people who believe income taxes can rise skyward, leaving nothing but positive effects, yet in this case, a 3% increase in the sales tax is enough to create economic carnage.

A more fundamental hypocrisy is found in Krugman’s recent comments regarding the call for in patience as we wait for positive results from Abenomics:

A weak yen has yet to give Japanese exports a big lift, but economist Paul Krugman says do not despair.

“People are overreacting to short-term slowness,” Mr. Krugman said in a Thursday interview in Tokyo with The Wall Street Journal. “I would still say wait.”

He said it takes time for manufacturers to adjust their production after currency changes and cited the experience of the U.S. after the 1985 Plaza Accord, an agreement between five major economies to allow the U.S. dollar to weaken. The deal led to a rebound in U.S. export growth but it took several years to emerge, Mr. Krugman said.

 

The Keynesian rallying cry that ‘in the long run we’re dead’ has been long used to justify economic intervention on the basis that if we don’t do anything now to stop the economic woes that ail us, in the long run there will be carnage as a result. The idea that markets should be left alone to achieve price discovery and to adjust to new economic realities, however painful these adjustments might be in the short run, is portrayed as the height of folly. Yet Krugman is advocating that time be afforded Abenomics so that producers can adjust to the new Abe created economic situation. The only difference between the scenarios is that Abe took bold action, whereas allowing uninterrupted price discovery is inaction. The inevitable failures of those bold actions of Abe are now there for all to see.

 

 

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