Shinzo Abe

In yen's fall, the end of Japan's higher living standards

Andy Xie says arresting deflation and raising nominal GDP will not bring back growth

PUBLISHED : Saturday, 23 February, 2013, 12:00am
UPDATED : Friday, 30 September, 2016, 2:13pm


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The Japanese yen has plunged 17 per cent against the dollar and more against the euro since its high in November last year. Some officials in the Abe government gleefully egged on the currency sellers. Their aggressive attitude has sparked fears of a currency war. But while Japan's official attitude may be distasteful, a yen fall is justified: it would happen on its own sooner or later, without the Abe government cheering it on.

Since the 2008 financial crisis, the world has seen major currencies depreciating in turn. The dollar fell as the US Federal Reserve printed money, first to bail out America's bankrupt banks, then to stimulate the economy, and now to prop up the property market.

A fall in the euro followed as the euro zone's debt crisis sparked fears of a break-up, and the European Central Bank rushed in to keep bankrupt governments afloat.

Now recession and deflation are sending Japan's central bank down the same path of printing money. Relative to the US and Europe, the Japanese economy has deteriorated. The yen, which had not reflected this change, has been adjusting accordingly.

This rotating currency devaluation isn't a war. The turn-taking reflects comparative economic fundamentals. It is as if a central banking plutocracy is colluding to debase paper money without causing panic. Today's central bankers, no matter where they are, are cut from the same cloth: they believe that printing money could help. Indeed, it has helped some people, including the bankers who plunged the world into crisis while fattening themselves.

For the rest of us, the money printing has merely imposed an inflation tax. In terms of the ostensible reason for printing money - to drive economic growth - the policy has failed miserably. After five years of loose money, the economies of Europe, Japan and the US contracted simultaneously last quarter.

When a medicine isn't working, it could be the wrong one, or the dosage may not be sufficient. The world's central bankers insist it is the latter without any evidence to back it up. Increasing the dosage of the wrong medicine will eventually kill the patient. That may be the fate of the global economy. An inflation crisis isn't too far down the road.

There are strong reasons the yen's depreciation will continue. Japan has long enjoyed a much higher standard of living than its neighbours. This was made possible by a price premium for made-in-Japan products. However, this has pretty much vanished. In some cases, like electronics products, Japanese prices are falling as local companies have missed out on the mobile internet boom.

The auto industry is Japan's pillar now. Japanese cars still enjoy a good reputation, but their competitive advantages are slim. Moreover, the auto industry suffers from global overcapacity. Japan's premium in living standards cannot be sustained by such a slim advantage.

The common view is that the Bank of Japan needs to adopt US-style "quantitative easing" to combat Japan's chronic deflation, which in fact reflects the country's declining competitiveness.

The yen has been strong because Japanese have preferred to deploy their savings at home. But Japan's competitiveness couldn't match the yen's level that Japan's savings have been able to support. Deflation is a market response to the inward nature of Japanese capital.

Curbing deflation won't bring growth to Japan. The country has a shrinking workforce and is losing out in growth industries. It cannot gain market share in global trade or boost consumption. Through a weak yen, Japan is essentially adjusting down its living standards through the exchange rates, rather than declining income.

The biggest factor for the yen's misfortune is the change in Japan's savings balance. The population is ageing. Hence, Japan's savings rate may turn negative, and the country will need to pull back its stock of savings stashed abroad. This force will keep the yen in a bear market for the next decade or two.

Japan's nominal gross domestic product has shrunk one-tenth from its peak. By curbing deflation, Japan will raise its nominal GDP. As Japan cannot generate inflation through wage increases, it has to do so through its imports. To achieve a 2 per cent inflation target, the yen may need to fall to 140-150 against the dollar within five years.

A more bearish approach is needed to keep the government from going bankrupt. Its debt is over 200 per cent of GDP. If the sustainable level is 80 per cent, then nominal GDP needs to rise substantially, and that would require the yen to rise above 200.

In the short term, the yen's decline may have overshot. It is mainly driven by foreign speculative capital, egged on by Japanese officials. This kind of money is footloose. When the yen bounces, it will all flee. Watch out for a sharp recovery in the yen's value soon.

But it won't be the end of its bear market; more like the beginning.

Andy Xie is an independent economist