The radical force of ‘Abenomics’
‘The 3.5 percent gross domestic product growth announced by Tokyo Wednesday suggests that Japan may be the fastest-growing economy in the G7. Since the Tokyo stock market hit bottom exactly six months ago, the Nikkei share index has soared almost 80 percent. Meanwhile, the yen has experienced its biggest six-month move against the dollar. All these events appear linked to the election of Shinzo Abe and the regime he has installed at the Bank of Japan.
Even after 20 years of stagnation, Japan remains the world’s third-largest economy, with a 2012 GDP of $6 trillion, equal to France, Italy and Spain combined. Financiers, business leaders and economists everywhere are starting to ask the obvious question: Is Japan finally taking the truly radical action required to fix its economy and end its “lost decades”?
This, however, is the wrong question. It confounds two very different issues – which need to be carefully distinguished to understand what’s happening in Japan.
The first question is whether Japan is truly committed to actions far more radical than anything attempted in the past 20 years. The second question is whether these actions, if pursued with determination and persistence, will fix Japan’s economy.
The first question was answered with a clear “yes” in March, when Abe appointed Haruhiko Kuroda as the governor of the Bank of Japan. Kuroda is an independent thinker, light-years from the consensus-seeking bureaucrats who have dominated Japanese policymaking for 20 years.
Kuroda demonstrated this immediately, in his first meeting of the BoJ council. He announced a monetary stimulus of staggering proportions – roughly three times larger, relative to the size of the Japanese economy, than the Federal Reserve’s quantitative easing in the United States.
But that still leaves the second question: Will Japan’s unprecedented macroeconomic expansion succeed in delivering the hoped-for economic growth? The answer is “maybe.”
Most bottom-up analysts, economists and investment analysts, who study companies and industrial sectors in detail, put the probability of success at well below 50 percent. Japan, after all, has profound structural problems: a shrinking population, misallocation of investment, enormous public debt, protectionist lobbies in service industries and agriculture, inflexible labor practices, unimaginative management – the list could go on. None of these can be fixed by monetary policy.
Why, then have stock market investors turned so bullish? Because top-down investors, who seek to profit from macroeconomic trends, have ignored the skepticism of bottom-up investors. To see why they have done this – and why they may be right – let us return to my two questions.
Bottom-up analysts, who think mostly about structural issues, quite reasonably argue that macroeconomic policies, however bold, will not help Sony invent the next iPhone. They will not turn frugal pensioners into spendthrifts or stop Japanese companies from hoarding profits instead of distributing excess cash to shareholders through higher dividends or to workers through higher wages.
Macro-investors, on the other hand, see unprecedented fiscal and monetary expansion as a good enough reason to buy Japanese equities and sell the yen. But if bullish macro-investors keep acting on Japan with enough conviction, they could change Japanese economic reality and win their intellectual contest with skeptical bottom-up analysts.
This could happen for four reasons.
First, the wealth effect created by a rising stock market and a falling currency could transform some structural problems. Andrew Sheng of the Fung Global Institute has calculated that the gains in Japan’s household wealth resulting from the recent market movements have already been equivalent to almost 40 percent of GDP. This extra wealth has already contributed to big improvements in consumer confidence and is likely to boost consumer spending and business expansion, especially in service industries. Similarly, the extra profits for Japanese exporters resulting from the weak yen are bound to increase wages and dividends, also encouraging more consumption.
Second, because the bull market in Japanese equities has largely been driven by investors, who focused on the macroeconomic issues, the vast majority of traditional long-term investors, who concentrate on structural issues and bottom-up company analysis, have missed one of the greatest investment opportunities in years.
If Japan’s stock market gains are soon reversed, this will not matter. But the very fact that many traditional investors have been left behind suggests that the bull market in Japan may have a long way to go, rather than being near its peak. If the bull market continues even a few months longer, skeptical bottom-up investors will have to start buying if they want to stay in business.
As these investors are drawn in, they will find reasons to believe that corporate and economic fundamentals are improving. Instead of asking whether monetary policy will help Sony invent the next iPad, they will start to speculate that Sony must have some brilliant new products on the drawing board ‑ since its stock price has risen so fast.
Third, if bullish macroeconomic analysis starts to overwhelm structural skepticism, this change in expectations can itself transform economic reality. Investment, consumption and employment would all accelerate strongly if bullish financial markets generated confidence in Japan’s long-term growth prospects. Japan could then become a classic case of what John Maynard Keynes described as “animal spirits” and what George Soros calls “reflexivity” – the capacity of financial markets to change economic reality, not merely to reflect it.
Finally, the macroeconomic stimulus of the past few months is only the beginning, not the end, of the Abe program. Abenomics has been described as a quiver with three arrows – fiscal stimulus, monetary expansion and structural reform. The third arrow will be fired only if Abe wins the Upper House election in July.
After that election, Abe is almost certain to make structural reforms in areas such as international competition, female labor participation, employment deregulation, lower energy prices and corporate taxation. These reforms will likely meet with opposition from powerful political lobbies. But some, at least, are almost certain to go ahead.
The reason is that Japan will have no choice. The fiscal and monetary expansion started in the first few months of Abenomics has been so extreme that there is no turning back. Unless Japan can achieve much faster economic growth, Abe’s radical experiment with macroeconomic stimulus will create a debt and monetary overhang so huge that it will bankrupt the financial system and possibly trigger hyper-inflation.
In short, Abe has bet his country on the success of his economic program. He will now be forced to do whatever it takes to achieve strong growth, both through macroeconomic stimulus and structural reform.
The financial arithmetic of Abenomics means that tolerable stagnation is no longer an option for Japan.
PHOTO (Insert A): Bank of Japan Governor Haruhiko Kuroda (C) speaks with the media upon arriving at a hotel to attend the Asian Development Bank’s annual meeting in Greater Noida, on the outskirts of New Delhi May 2, 2013. REUTERS/Adnan Abidi
PHOTO (Insert B): A passerby is reflected in a stock quotation board at a brokerage in Tokyo May 13, 2013. REUTERS/Issei Kato