The Japanese stock market has seen good returns in 2013 on the back of the election of Shinzo Abe to lead the country’s government. His Abenomics economic plan, which involved a mix of stimulus and monetary policy, drove the Nikkei up by more than 40% so far in 2013. There are reasons to believe that the plan cannot last forever, and reasons to believe that it may be harming the world economy.
According to the most recent letter from Michael Pettis, Japan has a balancing problem. Concentrating on the next few years, the supposed life expectancy of Abenomics, Pettis says that Japan’s current account surplus is bound to creep up. That could mean either disaster in Japan or problems in the rest of the world.
Japan’s current account
Japan is currently attempting to devalue its currency relative to other world currencies. Pettis doesn’t see that as a simple direct relationship, however. Changing relative currency value doesn’t increase the current account surplus by changing the relative cost of goods, it does so by changing the relationship between savings and investment. It acts as a tax for households on imports and as a subsidy on industry for exports.
The national savings rate rises as consumption falls and production rises. Investment will likely not move up at the same rate as savings, leaving a current account surplus in Japan. This, according to the piece, is an attempt to increase competitiveness and increase the total share of demand that Japan gets from the rest of the world.
That all seems like a relatively good system, but there is a problem: the world is not growing. The United States is stumbling toward recovery, Europe is still struggling and China is slowing down. Without an increase in world demand, Japanese imports either have to displace goods produced abroad, increasing foreign employment, or if foreign powers protect themselves, higher unemployment inside Japan.
If the world is not growing, or is growing very slowly, macro-economics is essentially a zero-sum game. Investments must equal savings in the world economy. Japan’s current account surplus lowers the surpluses, or deepens the deficits, of those it trades with.
Japan’s debt problems
On top of the problems Japan has with trying to fuel growth through an increase in exports, the country is dealing with one of the highest debt-to-GDP ratios in the developed world. Pettis says that the country is benefiting from its almost zero interest rates, but economic growth could throw the balance off.
Interest rates lower than economic growth, as they are in Japan right now, mean the country’s wealth is disproportionately transferred to borrowers instead of savers. Japan may be forced to raise interest rates. If it does not, it represses household income. Japan will not be able to service its debt at high interest rates, however.
Japan is in trouble, and there seems little way out. At zero interest rates the debt is manageable, at high interest rates it is unmanageable or economic growth is unsustainable.