The economic policy of Japan’s new Prime Minister Shinzo Abe – dubbed ‘Abenomics’ – centres on weakening the yen in a bid to revive the economy. It has been welcomed by exporters and boosted the Stock Market, but it has a downside. Japan, now importing 90 per cent of its energy resources, is running the biggest trade deficit since records began.
Japan’s weaker yen policy increases its trade deficit
JAPAN is beginning to realise that the policy of a weaker yen, promoted as a key to economic revival by the new government of Prime Minister Shinzo Abe, has a dramatic and potentially dangerous downside.
Mr Abe's approval ratings improved after the election, a phenomenon not seen during the tenure of the last six prime ministers, including his first term in 2006-07
The weakening of the currency, which began immediately after the announcement of a general election in mid-November 2012 because Mr Abe’s Liberal Democratic Party was expected to regain power, has been welcomed by exporters in the industrial sector.
It is particularly popular with leaders of the automotive, electronics, machinery, chemical and precision instruments industries.
Foreign investors have caught the wave and pushed Tokyo’s Stock Market to levels not seen since mid-2008.
Mr Abe enjoys increasing public support. He is portrayed by the mainstream media as having learned from past mistakes.
His approval ratings improved after the election, a phenomenon not seen during the tenure of the last six prime ministers, including Mr Abe’s first term in 2006-07.
The industrial exporters’ finances may look better in the short term, as the currency they earn abroad translates into higher yen revenues and profits in Japan. But the reality is far more complex.
First, a weaker currency is unlikely to boost the competitiveness of ‘Japan Inc’. It may improve the bottom line, but it also helps further delay urgently needed reforms in the corporate sector, such as an increased internationalisation of mid-sized companies; the development of globally integrated management systems; and consolidation in the hyper-competitive domestic market, where more than 80 per cent of executives – far more than in any other industrial country – believe that they are in a price war.
The relief that comes with a weaker currency will exacerbate the traditional propensity of Japanese executives to leave painful change to their successors, avoiding conflict and disharmony during their tenure. This is particularly true for many of the country’s large, bureaucratically managed corporations in internationally uncompetitive sectors.
If the competition matches the lower prices - if, for example, Korean car makers cut their prices accordingly - the positive effect of the weaker yen will be zero
Second, the assumed overall positive effect of price cuts in international markets requires that the demand for goods is elastic enough to offset the negative effect of the lower price for producers. For example, a ten per cent price cut for a Japanese car in the United States market may result in sales of five, ten or 20 per cent more units, depending on demand in the relevant market sector.
For products with a significant variable cost (unlike software, where variable costs are practically zero), the increase in units must be quite high to offset the negative effect. This is particularly true in industries which procure raw materials, parts, components and modules in foreign markets and have to pay for them in dollars or euros.
Finally, if the competition matches the lower prices of Japanese manufacturers - if, for example, Korean electronics or car makers cut their prices accordingly - the positive effect of the weaker yen will be zero.
While the positive economic effects of a currency devaluation depend on various assumptions, the negative effects are certain.
Japan’s trade deficit nearly tripled to a record 6.9 trillion yen (approximately US$80 billion) in 2012. Its deficit with its biggest trading partner, China, hit a record in 2012, at 3.5 trillion yen (approximately US $40 billion), while trade with the European Union slipped into the red for the first time.
December’s balance of trade in goods showed a deficit for the sixth straight month at 642 billion yen (approximately US$7.5 billion).
The key driver is the drastically increased import of energy resources - Japan currently obtains more than 90 per cent of these from overseas.
The shutdown of nuclear power plants following the Fukushima disaster forced up imports of liquefied natural gas to a record 87 million metric tons last year
The shutdown of nuclear power plants following the Fukushima disaster in March 2011 forced up imports of liquefied natural gas to a record 87 million metric tons in 2012. The gas cost six trillion yen (approximately US$70 billion), accounting for 8.5 per cent of the nation’s total imports.
Demand for energy by households and firms is constant, so the value of imports increases, whereas the gain in value of exports remains uncertain. The gap between the two widened in January 2013, when Japan registered its largest monthly trade deficit of 1.6 trillion yen (approximately US$18 billion).
Thanks primarily to the weakened yen, the value of imports rose by 7.3 per cent year on year to 6.4 trillion yen, with the value of oil and liquefied natural gas imports jumping by 34 per cent and 11 per cent respectively.
The deficit with China hit a record 655 billion yen against a backdrop of rising imports of electronic parts, components and finished products.
Exports, however, recovered moderately, for the first time in eight months, up 6.4 per cent to 4.8 trillion yen. The effect on the trade balance is negligible, as about 77 per cent of imports are denominated in foreign currencies, compared with nearly 62 per cent of exports.
The fact that the weak yen turns out to increase Japan’s trade deficit further, and the necessity to finance it, indicates that ‘Abenomics’ is rooted in short-term political goals rather than sound economics, particularly with regard to the Upper House election this summer.
The policy may be celebrated by the beneficiaries of 20th Century-style stimulus packages, unbridled quantitative easing and a weaker currency, both domestically and internationally, but it can also be seen as a massive gamble at the expense of the future of the country and, in case of a worst-case catastrophic scenario, the world economy.