In Abe-yance

Why trade still holds the key to Japan’s growth  |  The decision by the Bank of Japan to boost the Japanese economy by around $712bn at the end of October was Quantitative Easing (QE) on such as scale that it took markets by surprise. It signals the determination of Japan’s policy makers to “do whatever it takes” to boost Japan’s sluggish economy, to increase the value of the Yen against the US Dollar and to prevent latent deflationary pressures from taking hold yet again. Boosting the Yen will import some inflation while it is hoped the QE will halt the contraction of Japan’s economy of 7.1% seen in Q2 this year.

Shinzo Abe is now faced with a decision: does he raise the sales tax introduced in April 2014 from 8% to 10%? That there should even be a question around this is remarkable.

As Figure 1 shows, Japan’s imports were not impacted immediately by the sales tax and in fact rose between April 2014 and September 2014. However, we are forecasting a marked drop in imports from October, which, even with a brief spike in March 2015, will still represent a negative trend to the end of Q1. There is little sense in damaging what is at best a fragile recovery and this policy should be put on hold for the time being.

 

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Figure 1  |  Monthly value of Japanese imports (USDbn) versus JPY-USD spot, June 2001-September 2014
Source  |  DeltaMetrics 2014, Bloomberg (currency data)

 

Japan’s imports since April alongside a marked depreciation in the value of the Yen point to one of the persistent paradoxes of Abenomics: why has trade failed to pull Japan out of its economic torpor?

Delta Economics is of the view that, since the Fukushima disaster in 2011, Japan’s policy makers have had relatively little influence over trade through manipulation of the Yen’s value. This is quite clear from Figure 2, which shows Japanese Terms of Trade in relation to the value of the Yen against the US Dollar.

 

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Figure 2  |  Japan’s terms of trade (value of exports in terms of value of imports) in relation to Yen per USD Last Price Monthly, June 2001-September 2014
Source  |  Delta Economics analysis

 

The depreciation in the Yen against the Dollar pre-dates Abenomics by six months and, despite a mild pick-up in the terms of trade between July 2012 and April 2013, the impact of the currency depreciation since has been, perversely, for the terms of trade to deteriorate further. In other words, export values have not increased relative to import values, which might have been the result of an expected boost to exports from a currency devaluation.

This has less to do with fact that the relationship between the currency and trade has broken down (the so-called J-curve effect) and more to do with the fact that Japan’s dependency on energy imports has increased in the wake of the Fukushima disaster. Japan’s terms of trade deteriorated by nearly 9% between the disaster in March 2011 and the real start of currency depreciation in July 2012; over the same period, energy imports rose by nearly 14% (Figure 3).

 

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Figure 3  |  Monthly value of Japanese imports (total and energy), June 2001- June 2015
Source  |  DeltaMetrics 2014

 

The figure shows two things: first, Japanese imports generally have fallen in value since the immediate post-crisis recovery and, in real terms will only be at the value they were immediately pre-crisis by June 2015. Insofar as Japan’s imports reflect its demand, this is a sharp reminder of the fact that the economy is still sluggish. Second, although energy imports in 2014 represent nearly 37% of Japan’s imports compared to just under 30% at the end of 2010, the fact that growth is also forecast to be sluggish into Q2 2015 suggests that industrial as well as consumer demand is likely to remain flat for some time.

 

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Figure 4  |  Japanese trade – full of paradoxes
Source  |  DeltaMetrics 2014

 

Japan’s demand is likely to improve slightly in 2015 as witnessed by the mild pick up in imports that we are predicting for 2015. Exports, which have been sluggish globally as well as in Japan, will pick up. Electronics exports, for example, may well recover from the contraction in growth of 3% this year to flat or slightly negative growth in 2015. Similarly we are predicting a slight slow-down in the contraction of automotive exports in 2015.

The fact that flagship sectors, like cars and electronics are likely to see negative trade growth even into next year may suggest that Japan’s economy itself is no longer competitive. However, this is too simplistic. In an era of global supply chains, it is a mistake to suggest that the decline in exports represent the declining competitiveness of a whole country: global corporations locate globally to take advantage of competitive strengths elsewhere and Japan’s companies do this as much as their German, American or South Korean counterparts.

In a sense, then, it is imports that are of more interest because they illustrate some of the underlying patterns of demand within an economy. Japan’s policy makers have had their foot on the economic accelerator and brake at the same time, arguably since the Fukushima crisis rather than the beginning of Abenomics. Deliberate currency depreciation and fiscal stimulus alongside a sales tax has done little to boost exports or stimulate domestic demand. And because of the greater energy component of imports, falling oil prices now mean that Japan will be as prone to the disinflationary pressures seen in Europe and Asia. There is little that further currency depreciation can do to prevent this and while falling energy prices may help, if every country has falling energy prices, then it does little to boost comparative advantage.

Similarly, increasing the sales tax by a further 2% now may not have much of an effect on an already fragile start into 2015 that Delta Economics sees. It could well have a further negative effect in Q2 2015 and this is something to be avoided at all costs.

Trade Returns?

Why Obama was wrong to leave Japan without a deal | There is little doubt that President Obama’s visit to Asia was all about trade. The TransPacific Partnership (TPP) negotiations aim to enhance trade, economic integration and growth across the Asia-Pacific region particularly through the establishment of a free trade area (FTA) between the participants. That President Obama left Japan without an agreement is significant for the future of the TPP and his warnings to South Korea about its treatment of US exporters did nothing to reassure markets that the agreement was any closer.

However, at first glance, the relationship between inter-regional trade and key Asian markets and currencies would suggest that there is little for markets to be concerned about. US exports to and US imports from key countries within the region are strongly and negatively correlated with the Hang Seng Index (all above -0.72) and with the S&P 500 (again, all above -0.55). Similarly, Indonesia’s trade with the US is mildly but negatively correlated with the Rupiah’s value against the US dollar and India’s trade is mildly but again negatively correlated with the value against the US dollar of the Rupee. The only exception is Thailand: its exports to the US are highly and positively correlated with the Bhat’s value against the US dollar at 0.85.

If the links are so weak with currencies and strong but negative with key markets, why attempt to build a Free Trade Area? The conclusion from these largely negative correlations must surely be that Asia-Pacific is better served by intra-regional trade. The US, in this context has more to gain from the relationship than does Asia.

Japan-US trade is a proxy for countries elsewhere in the region and illustrates how the relationship between equity and currency markets and US-Asia trade has broken down since the financial crisis. For example, the relationship between Japanese and US trade was positively correlated with the Nikkei until July 2009. Although exports from Japan to the US continued to grow until September 2011, the correlation turned negative after that point and is particularly marked since the beginning of 2013, ironically, the start of President Abe’s tenure, as illustrated in Figure 1. While overall the correlation is negative at -0.55, much of this is accounted for by the post-crisis period.

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Figure 1 | Value of Japanese exports to the United States, June 2001-Dec 2014 (USDm) vs Nikkei Last Price Monthly, June 2001-March 2014

Figure 1 Source | DeltaMetrics 2014

Similarly, as with other economies in the region, there is also a weak, but negative correlation between Japan’s exports to the US and the value of the Yen against the USD (Figure 2).

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Figure 2 | Value of Japan’s exports to the US, June 2001-Dec 2014, USDm vs Yen per US Dollar, Last Price Monthly, June 2001-March 2014

Figure 2 Source | DeltaMetrics 2014

Again, the most marked post-crisis turning point in the relationship between exports to the US and the value of the Yen is at the start of Abenomics where the Yen has been depreciating against the dollar. This cannot be seen as anything to do with trade HGH since it is a deliberate policy choice, and the correlation, -0.29, reflects that. However, what is very clear from Figure 2 is that the currency depreciation is not having a marked effect on increasing exports to the US.

And again like other countries in the Asia-Pacific region, Japan is heavily dependent on intra-regional trade: some seven out of ten of its top export destinations are within the region. The correlation between Japan’s terms of trade (the value of exports in relation to the value of imports) and the value of its currency against the dollar is positive at 0.79 suggesting that the depreciation of the Yen is likely to be important in shoring up the value of its exports more generally.

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Figure 3 | Japan’s terms of trade (value of exports/value of imports), June 2001-Dec 2014 vs JPY per US Dollar, Last Price Monthly, June 2001-March 2014

Figure 3 Source | DeltaMetrics 2014

These negative correlations between trade and equity and currency markets are replicated across the region. Indian trade with China is negatively correlated with the value of the Rupee against the US Dollar, for example. But this should not be a surprise. Much of Asia is still emerging and all of Asia-Pacific is heavily dependent on trade with itself. The structure of trade is, even between advanced economies within the region and less advanced economies, dominated by commodities and intermediate manufacturing; the equity and currency values, in contrast, have been heavily driven by speculation in the post crisis period and while South-South trade remains set to grow by just 5.3% over the next year it will be some time before this type of hubris resumes (Figure 4).

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Figure 4 | USDbn value of North-North and South-South trade, June 2001-Dec 2015

Figure 4 Source | DeltaMetrics 2014

Neither the US nor Asia can afford to leave the negotiations in limbo, not just because of the importance of export-led growth in a sustainable global recovery. There are two reasons for this. First, an FTA in the Asia-Pacific region that extends beyond the South-East Asian nations (already represented through ASEAN) would create advantages from the reduction of costs of trade between nations and potentially help to shore up the south-south trade that was so much a feature of post-crisis recovery but that has waned since.

But second, the US would become a minority trading bloc accounting for just under 12% of world trade compared to the nearly 35% of world trade that the Asia-Pacific region accounts for and the just over 34% that the European Union accounts for including intra-regional trade. In the end, by leaving Asia without a trade deal, the US has weakened rather than strengthened its position: China is currently excluded from TPP but is critical to its trade structure. There is, potentially, more scope for an agreement between all nations in the region including China than there is between the region and the US if the US does not take a pragmatic approach to negotiations. President Obama and his team should be thinking about trade returns in every sense.