Every year, top global financial policymakers gather in Jackson Hole, Wyoming for a summit. Bank of Japan (BOJ) Governor Haruhiko Kuroda was there, and delivered a disappointing message to those who were waiting for a ramp-up of the bank’s money printing. Although he allowed for future re-evaluation, he said he believed that Japan was on target to reach its 2 percent inflation goal by 2015, and finally break out of its long “deflation trap.”
Some outside analysts don’t agree. By its own admission, the BOJ sees inflation tracking down to 1 percent by December of this year. Morgan Stanley researchers point out that to reach the inflation target, Japan’s core CPI would have to hit 2 percent by April 2015 and stay there through year-end.
Reporters at Jackson Hole peppered Mr. Kuroda with questions about possible additional efforts beyond the BOJ’s bond purchases -- such as price-level targeting (which would involve a deliberate inflation overshoot to compensate for previous inflation that was below target) or nominal GDP targeting (which would push easing until a nominal GDP target was reached). He demurred, saying that the current program was enough and would stay in place, although he wouldn’t rule anything out for the future.
Abenomics Hits a Wall
Japan has never recovered from its early 1990s economic and financial market bust, languishing in sub-par growth for over two decades. In 2012, Japanese Prime Minister Shinzo Abe took office promising “three arrows” to hit the target of economic revival.
The first was a ramp-up in fiscal expenditures -- classic Keynesian stimulus. With very high debt levels going into the program, though, the government’s firepower here was limited. The second was an aggressive monetary stimulus, through a bond-buying program by the BOJ that made U.S. central bank’s quantitative easing look tame. The third arrow was a raft of structural reforms to make the Japanese economy more open and more competitive.
The “Three Arrows” -- Hit and Miss
What success has there been?
The first two arrows are generally thought to have hit near their targets. Some inflation has been generated. The Yen has weakened somewhat, and the Japanese stock market, albeit with pullbacks, responded well to the first two arrows.
However, the “third arrow,” which most observers agreed was the most significant one, has not quite landed where Mr. Abe wished. He has not pressed as hard as he could have for difficult reforms -- such as those that would open up protected sectors of the Japanese economy, or allow more foreigners to work temporarily in the country.
He has also spent some of his political capital on other causes not as closely related to the economy, such as a push to allow Japan a more aggressive military stance. Admittedly, his administration has faced the aftermath of the Fukushima nuclear disaster as well as severe geopolitical tensions with China -- problems that would have challenged any reformer.
Japan’s real economy has not shown that it’s getting ready for a takeoff. Although the government can point to some positive data, real GDP is flat for the past twelve months. At Jackson Hole, Kuroda cited domestic consumption and investment as likely to expand in coming quarters, according to the BOJ’s assessment.
From our perspective, Japan is facing some very long-term problems, and we do not see a clear path for Mr. Abe to address them.
First is Japan’s demographic situation. It’s an aging country with a shrinking population. That means retirees are coming out of the workforce, leaving the relatively well-paid jobs that they got back when Japan, Inc.’s “lifetime employment” promise was still a going concern. The younger people now entering the workforce are finding lower-paying jobs, as well as more contingent employment.
That means that wages are trending down, which does not bode well for inflation -- or for Mr. Abe’s political fortunes in the short- and medium-term. With inflation ticking up and wages failing to keep pace, workers are becoming more disgruntled. Ultimately, that could cost Mr. Abe his job, if things don’t improve.
So far the “virtuous circle” of inflation and higher wages that Mr. Abe promised at the beginning hasn’t materialized. At Jackson Hole, Mr. Kuroda went as far as to say that a “visible hand” -- meaning government intervention -- would be needed to make wages rise. If that’s what is needed, we are skeptical that it can be implemented.
The Fukushima disaster has also hurt the Japanese economy. The shutdown of Japan’s nuclear industry has meant the importing of much more oil and gas, pushing Japan’s trade balance deeply into the red, and far outpacing any improved export performance from a weaker Yen. Mr. Abe is trying to get nuclear plants restarted -- but the move is unpopular and is costing him a lot of political capital.
Pension Funds Move to the Stock Market
A silver lining for investors may be a push for Japan’s giant state pension fund, the GPIF, to increase its holdings of Japanese stocks. We have been hearing about such moves for some time, but according to the latest plans, the GPIF will up its stock allocation from 16 to 20 percent of its holdings. That increase would equate to about 1.2 percent of the total capitalization of the Japanese stock market. It’s good -- but not enough to make us wildly bullish.
Investment implications: Economic data for Japan are ambiguous. Fiscal and monetary stimulus likely won’t be able to revive the Japanese economy by themselves, and many observers are wondering whether anyone has the capability to enact deeper structural reforms that would overcome some of Japan’s secular problems. We will continue to monitor those reform efforts.
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