The Japanese government is delivering the
other half of its fiscal policy today. Earlier, Abe decided to
postpone the sales tax hike for the second time. Today, the cabinet
approved a JPY28 trillion (5.6%) of GDP package.
The market is looking past the headlines and
is not impressed with the details. The JPY4.6 trillion of measures
(~1% of GDP) is a little bigger than last year’s supplemental budget (JPY3.5
trillion). The government projects it will boost growth by 1.3% (but does
not specify the period). Many economists are skeptical. Actual spending in Japan notoriously is a
fraction of the budget amounts, and the multiplier effect seems to be
small.
Prior to the
news, the Bloomberg survey found the
median forecast was for the Japanese economy to expand (year-over-year) 0.5%
this year and 0.8% next year. These estimates may be a tweak on the margins but are unlikely to change
the general profile. The plans appear to be largely a bromide
that can do little but offers very
temporary and very mild economic relief. It will not do much to close the
output gap, which may keep the BOJ’s inflation target as elusive as
ever.
Of the JPY28 trillion headline figure, a
little less than half (JPY13.5 trillion) includes fiscal measures. Of
this amount, JPY7.5 trillion are spending measures, which will start (but not
necessarily finish) this year. The other JPY6 trillion is low interest
rate loans.
There is a JPY15k cash payment program for low-income households.
There are also funds to increase salaries of care-givers.
JPY3.4 trillion has been earmarked to address demographic changes. The
fiscal plans also include JPY1.3 trillion to mitigate the effects of Brexit on
small and medium size Japanese businesses.
However, one of the reasons that many
economists are skeptical is that the bulk of the funds are one-off spending
that may help in the very short-term, but once spent, has a little-sustained impact. It means
that in a year from now the Abe
government could very well be debating another supplemental budget.
This is precisely the pattern that has
played out repeatedly in Japan for years. One-off fiscal goose, rinse and
repeat.
What ails Japan
and the reason it struggles to maintain positive growth momentum and stable
prices are not that its ports are not deep enough or that its does not have enough
maglev trains. It seems that
the government is making the same mistake as the BOJ. The BOJ
believes that buying a wide range of financial assets, including commercial
paper, corporate bonds, government bonds, ETFs and REITS, that the price of
consumer goods will rise. Abe believes that public investment and low
interest rate loans to businesses will put Japan on a sustainable growth
path.
Japan’s GDP is about JPY500 trillion.
Abe has set a goal of JPY600 trillion in by 2020. Perhaps setting the
goal is more politically important than achieving it. However, the
measures announced do not seem to address what ails Japan. At best, the
fiscal support leads to marginally better
short-term growth, without lifting the country’s growth potential. The
BOJ estimates trend growth around 0.2%.
It is well
known that Japan has a shrinking and aging population. On top
of that productivity growth is poor. There seems to be very little of the
stimulus aimed at boosting labor productivity. Part of the problem is that Abe
himself is divided. He has one foot in the “old” world:
faith, family, and flag. His cabinet, before and likely after tomorrow’s
reshuffle, reflects this. Several are former prime ministers or senior officials.
Abe’s other
foot is more modern. He recognizes the need to enhance the
role of women in Japanese society. He recognizes that the agriculture co-op is committed to defending its
rent-seeking claims, and is deterring the modernization of the Japanese
economy. He has tried introducing and instilling shareholder values among
Japanese businesses.
Despite full employment, Japanese wage growth
is meager. The low and now
negative interest rates mean that Japanese households need to save more
to ensure the same financial objectives. The government sector has recorded
persistent and large deficits, which have resulted in the world’s second-largest economy having accumulated debt
to the tune of close to 240% of GDP. The one sector in Japan that is in
surplus is treated like a sacred
cow.
Japan Inc has had record profits, access to
low interest rate loans, and all sort of cajoling by the government to boost
wages (which they haven’t). Domestic investment is weak. And
yet, Abe has cut their taxes and now makes more cheap loans available, even
though Japanese business cash holdings stand at record levels.
Nearly everyone is familiar with Abenomics
three arrows: fiscal stimulus, monetary stimulus, and structural reforms.
We suggest that there was a fourth arrow, and it was the international
diversification of Japanese pension funds. Much of the diversification
appeared to be on an unhedged basis. Japanese corporates are also
believed to have kept part of their foreign-derived
earnings in foreign currency instruments. This
helped fuel the three-year yen slump
when the US dollar went from below JPY80 to over JPY125.
The diversification program was largely a
one-off. It has continued but incrementally. However, the cycle
now appears to have reversed. In effect, Japanese investors were larger
sellers of yen. They were short yen. Given the expected returns in
Japan, the diversification cannot be unwound, but the short yen exposure could be reduced. That seems to be what is
happening. Now Japanese investors are believed to be raising hedge
ratios.
The JPY100.60 area corresponds to a 50% retracement of the Abe-inspired yen
sell-off. The 61.8% retracement is near JPY94.60. That
seems to be where the greenback is headed.
This area corresponds to what some economists might see as value.
Purchasing power parity is that level that economic theory holds currencies
will gravitate around in the long-run, based on the law of one price. The
OCED estimate fair value (PPP) for the dollar-yen exchange rate is near
JPY98.
What other level does dollar-yen gravitate
around in the long-run? Currencies gravitate around a long-term moving
average by definition. The 120 month (10-year) moving average of
dollar-yen is a rough and ready estimate of PPP. It is found near JPY99.80.