If European Central Bank (ECB) president Mario Draghi needed confirmation of why Europe should do all it can to avoid deflation, Japan has provided it. Digging yourself out of a downward spiral of stagnation and falling prices is difficult – and expensive.
The co-ordinated response to the stalling of Abenomics is radical stuff. Shifting the giant government pension scheme’s assets into domestic and overseas equities could direct around $12 billion of new money at the Nikkei index.
Cranking up Japan’s quantitative easing program puts Japan in the vanguard of the asset buying now that the Federal Reserve has ended its monetary stimulus. The fact that global markets only managed 24 hours or so off the QE drip shows how far from a return to normality we really are.
With inflation sliding ever further from the government’s 2 per cent target, something had to be done. The deflationary mind-set is firmly entrenched in Japan after years in which people have become resigned to no wage growth and falling prices. Rising import costs, a higher sales tax and tepid income growth have actually made things worse not better.
Heavy lifting
The hope is that a tight labour market, an improving corporate earnings outlook and some gentle arm-twisting by the government will finally see real, inflation-adjusted incomes rise. They need to because the message from the latest measures is that next year’s second sales tax hike is going ahead. Monetary policy is going to have to do the heavy lifting because Japan’s massive debt burden means the country can no longer delay putting its fiscal boat on an even keel.
So far this year, Japan has seemed to revert to its traditional role as investing’s perennial disappointment. After the spectacular rally in 2013 following Shinzo Abe’s election, normal service has resumed – another false dawn and a collective shrug from the markets. Since the Nikkei peaked in 1989, betting on a return to form has been an expensive triumph of hope over experience.
The slump in economic activity after Japan’s sales tax was hiked from 5per cent to 8 per cent in April seemed to confirm everyone’s worst fears about the world’s third-largest economy. The sceptics see Japan as doomed to a future of increasing irrelevance, with a shrinking and ageing population, uncompetitive exports and a testy relationship with giant neighbour and long-time enemy China.
There is more than a grain of truth in these concerns, but overall it is too gloomy an assessment. It would be wrong to underestimate what a galvanising effect a return to modest inflation would have on Japan. The latest measures confirm that the government and Bank of Japan are acting in concert (which hasn’t always been the case) and are determined to do “whatever it takes” to return Japan to a position of regional strength.
Mojo
Most importantly, Japan has seen the challenge from China and realised that, if it is to remain a force to be reckoned with in east Asia, it must find its economic mojo again.
To do that it must get serious about corporate sector reform, so new governance and stewardship codes and the use of shareholder-friendly return-on-equity benchmarks are necessary but not sufficient steps in the right direction. It probably needs to look long and hard at its attitude to women in the workforce and immigration, although it shouldn’t be assumed that either of these will actually happen.
Partly because of these two issues, Japan has a reputation for being a staid, stuck-in-the-mud sort of country that has lost the ability to compete on an increasingly challenging global stage. I can see where that view has come from, but I also look at the last 150 years of history and see a country that has on more than one occasion completely re-invented itself when it had to. I would not bet against Japan doing it again.
The final reason to give Japan the benefit of the doubt is that it is cheap. With Tokyo on 11 times earnings compared with Wall Street’s 16, investors have already priced in many of the undoubted challenges that lie ahead. It is much cheaper than Europe, which Draghi knows shares many of its demographic and competitive problems.
