Webcast 024 | Is global economics more important than geopolitics?

As we move into the final quarter of 2014 it’s time to take stock on what has been a disappointing year in many ways. Neither trade nor economic growth have been anywhere near as robust as many economists expected at the beginning of the year, and the final quarter of 2014 looks like it will be tougher rather than easier. Delta Economics is pretty bearish about the immediate future but are we missing some of the key economic facts that may make the picture look brighter?

Discussing this topic with Dr. Rebecca Harding and to sift fact from fiction is Dr. Andrew Sentance, Senior Economist Advisor of PwC and former Monetary Policy Committee member.

 

Webcast 024 Author  |  Rebecca Harding  |  CEO

Born in the USA

Why America’s trade policy matters  |  Last week it was announced that US GDP failed to grow at the rate in Q1 analysts were expecting. To add insult to injury, Gazprom decided it was going to conduct its trade with China in Yuan or Roubles rather than US Dollars. The market reaction was decidedly muted. Does this mean that traders are just so buoyed by sentiment that they are no longer betting on macro indicators at all? Or has the rise of the Yuan already been priced in?

Neither answer seems particularly satisfactory. The clue may rest in the reason why the annualised drop of 2.9% in GDP was so large. The cold winter and health care costs were a significant part of it, but, more importantly, some two-thirds of the drop was accounted for by weaker-than-expected trade performance. Trade, as we might conclude from Obama’s erratic attention to key trade agreements such as TPP with Asia and TTIP with Europe, is apparently less important to the US economy than assets prices, such as housing. A temporary drop in trade won’t do as much damage as a drop in sentiment that might stop people buying things; the US is not returning to recession. So, that’s alright then.

This is an ill-advised, if not downright illogical thought process. Make no mistake about it, trade matters to the US economy. Exports will be worth USD 1.6tn to the US economy in 2014 and imports some USD 2.3tn. Compared to 2001, the US’s trade openness (exports + imports as a percentage of GDP) has grown from 16% to nearly 28%. Delta Economics is forecasting that by 2020, trade will be 36% of GDP on current trends. More than this, as Figure 1 illustrates, trade is also highly correlated with the value of the S&P 500.

 

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Figure 1  |  Value of US trade (USDm) versus S&P 500, Last Price Monthly, June 2001-May 2014

Source  |  DeltaMetrics 2014, Bloomberg

 

So while traders themselves may not react to macroeconomic or trade-related news, the correlation of above 70% suggests that there are reasons why they should watch trade more closely. And in fact, the correlation with imports is slightly higher, at 71%, not least because of the size of the trade deficit that the US runs.

Much of that trade deficit is with China in particular and Asia-Pacific in general. In fact, the trade with the key global regions where US trade policy has currently stalled constitute 56% of US trade and Asia-Pacific is the most important of these in value terms.

 

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Figure 2  |  Value of US trade (USDm) with key trading regions: the EU28, ASEAN and Asia-Pacific

Source  |  DeltaMetrics 2014

 

Figure 2 shows clearly is that although trade with Asia-Pacific has grown by 4.5% in the last 12 months, the trajectory for the rest of the year is relatively flat for all regions. Much of this growth was in Q2 2013 for all three regions and year on year 2013-14 growth is likely to be much lower at under 2% for Europe and just above 3% for ASEAN and Asia-Pacific.

Admittedly US exports are growing relatively quickly at above 3% while imports are forecast to fall in 2014 by nearly 1%. But as the S&P 500 is more correlated with imports than it is with exports, this should give policy makers pause for thought: might it be that markets are perhaps more interested in the activities of US-based global supply chains in Asia that import into the US, than they are in the re-shoring of US jobs evidenced through higher levels of export activity?

 

2014-06-30_bornInTheUSA_fig03Figure 3  |  Why US Policy needs to think about Asia

Source  |  DeltaMetrics 2014

 

Figure 3 shows that the US terms of trade (the price of export in terms of the price of imports) are not especially correlated with the value of the Dollar against the Euro but are with the value of the Dollar against the Yen. More than this, although trade with Europe is strongly correlated with the value of the Dollar against the Euro, this may well be because the Euro is a trade currency rather than a speculative currency. What is quite apparent from Figure 3 is that the correlations across the board: with the S&P 500 acting as a proxy for US assets and sentiment more generally, and with the USD versus the Yen are significant with both Europe and Asia, but strongest of all with Asia, reinforcing the view that the TPP and the TTIP talks are vital to US trade, if not directly to US GDP.

Yet China will be excluded from TPP talks. As the US’s third largest export partner and largest import partner this seems odd, and with a trade deficit that the US runs with China is forecast to be some USD 370bn a reminder that actually the US cannot afford to be overly protectionist in its relations with China. The US terms of trade with China are 84% correlated with the S&P 500 underlining the importance of the fact that US companies have strong interests in supply chains that run into and out of China across the Asia-Pacific region.

 

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Figure 4  |  US terms of trade with China vs Yen per USD, June 2001-May 2014

Source  |  DeltaMetrics 2014, Bloomberg

 

Nowhere is the importance of supply-chain dependency more clear than in the trade competitiveness of US electronics. In 2001, the US had a Normalised Revealed Comparative Advantage (NRCA) in exports of Computers of 0.11 and in semi-conductors of 0.14. By 2006 in the case of computers and 2010 in the case of semi-conductors this comparative advantage had turned into disadvantage of -0.01 and -0.1 respectively. By 2014 the equivalent figures were -0.2 for both sectors. In fact, it is only the US’s increasing self-sufficiency in oil and natural gas that is improving the outlook for US exports with a near 50% improvement in the Revealed Comparative Advantage of mineral fuel exports by 2020. Even if the NRCA figure is still forecast to be mildly negative, this is a vast shift on its 2001 value of -0.62.

The wonder is why anyone should be surprised. From the mid-1990s onwards the globalisation strategy of large US multinationals was to outsource to China (and now the rest of Asia), the automated processes within semi-conductor and computer manufacture that could be done more cheaply but equally as effectively there. That process, now so established across more sectors, is hard to turn around once it has started and explains, to a large extent why US markets are so correlated with both imports and trade with Asia.

The problem was, as the song goes, Born in the USA. Maybe markets should be looking to Springsteen’s lyrics to predict what happens next:

“….Come back home to the refinery,
Hiring man says, “Son if was up to me….”

Hub or Cog?

Why Singapore’s trade diversity is key to its economic success  |  Singapore’s export trade has grown by 275% and its imports by more than 240% since 2001. As a measure of this, perhaps, its fifth largest import sector is cranes and crane components accounting by itself for $US7.6bn of Singapore’s imports. But the fact that the sector is also Singapore’s fifth largest export sector accounting for some $US 6.6 bn suggests that Singapore is more than a hub; it is also a cog in Asia’s trade machine adding value to the goods it imports and distributing that value across the region and beyond. It is this that makes it both dynamic and potentially vulnerable to any apparent slow-down in economic or trade growth forecast for this year.

Singapore’s stock exchange and its currency are highly correlated. With the STI, the value of the correlation coefficient over the past 12 years is 0.87, but with its currency’s value per US Dollar, the correlation is even higher at -0.97, as illustrated in Figure 1. In other words, as the Singapore Dollar strengthens against the US Dollar (i.e. one dollar buys fewer Singapore Dollars), trade rises and vice versa.

 

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Figure 1  |  Singapore exports (USDm) June 2001-April 2015 versus Singapore Dollars per USD, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

These correlations are important because they illustrate just how inter-dependent investment, trade and economic strength (measured through the value of the currency) are for Singapore.

This contrasts starkly with the other major trading hub in the Asia-Pacific region: Hong Kong. While the correlation between Hong Kong’s exports and the Hang Seng is very high at 0.89, the correlation with its currency against the US dollar is low at -0.51 – illustrated in Figure 2.

 

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Figure 2  |  Hong Kong exports, USDm value, June 2001-April 2015 vs HKD per USD Last Price Monthly, June 2001 – April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

This suggests two things: first, that both Singapore’s and Hong Kong’s role as a trading hub is important in determining investment in their key equity markets. Second, the relationships between core indicators of economic virility are quite different in Singapore and Hong Kong – while Singapore’s currency appears to be linked absolutely with its trade performance, Hong Kong’s does not.

This is replicated across other asset prices as well, illustrated in Figure 3’s infographic. What the chart shows is that Singapore’s trade is mildly more correlated with Emerging Market equities and the MSCI Emerging Markets index but is mildly less correlated with the S&P 500. Neither is correlated with the Nikkei. Correlations with currencies, in contrast, are weaker except for two emerging markets currencies – the Thai Baht and the Singapore Dollar, and the Japanese Yen.

 2014-05-12_hubOrCog_fig03

Figure 3  |  Correlations of Singapore and Hong Kong exports with selected Emerging Market and Global asset prices
Source  |  Delta Economics analysis

 

The difference in the magnitude of the correlations is small, but as it is consistent, it suggests that there is something in the role that trade plays that is different between the two countries. For example, Singapore’s top export sectors are refined oil, integrated circuits, printing and ancillary machinery, semi-conductors and crane machinery and parts. This reflects both Singapore’s role as an energy and infrastructure distribution hub, and as a cog, which adds value to imports before they are exported. Singapore semi-conductor export value in 2014 for example is expected to be US$9.3bn – nearly twice the value of its imports which we expect to be around US$4.3bn.

This role for innovation is particularly clear in pharmaceuticals where Singapore has been building capacity in its innovation system for nearly two decades. The medicines are its 7th largest export sector but they do not feature in the top 30 imports, suggesting domestic production is driving Singapore’s export strength in this sector, reflected in its strong correlation with the Nasdaq Index, as shown in Figure 4.

 

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Figure 4  |  Singapore’s exports of pharmaceuticals (USDm eye secretions in dogs), June 2001-April 2015, versus Nasdaq Last Price Monthly values, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

Singapore has built its indigenous export capacity through its structures to support innovation and entrepreneurship as documented by Delta Economics and the ACCA. However, its role as an energy distribution hub underpins its economic strength, as measured by its currency value and illustrated in Figure 5. Again, the correlation is negative – in other words, as the USD buys less of the Singapore dollar, exports of oil increase, with some USD 88bn expected to be exported in 2014.

 

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Figure 5  |  Singapore’s exports of mineral fuels (USDm), June 2001-April 2015 versus SGD per USD, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

Four of Singapore’s top five export partners are within Asia: China, Hong Kong, Indonesia and Malaysia. Its fifth largest export destination is the US. Hong Kong’s top five export destinations are China, Germany, India, Japan and the USA. China dominates its export partners with an expect export value in 2014 of over $US 290bn. Germany, in second, is small in comparison and likely to account for just under $US 30bn in export values in 2014. And while Hong Kong is important as an export destination for Singapore, Singapore ranks 7th of Hong Kong’s export destinations.

If China’s trade is slowing, then both economies will be affected. Interestingly, although Singapore’s export trade is more diverse across its partners, its export trade is as highly correlated with Chinese export trade as Hong Kong’s at 0.97. This reinforces the importance of China as a nation to the region as a whole, and to its two trade hubs in particular, and while it is likely to affect Hong Kong more than Singapore, the mechanisms by which this happens may not be fully transparent. Nearly 10% of the total USD value of China’s top importers is accounted for by re-imports. These are goods coming into China that originate in China – i.e. from the semi-autonomous regions that form China as a whole. China is Hong Kong’s largest export destination, but does not appear as an importer into China.

The transmission mechanism by which any contagion from China’s slow-down will spread is more likely to be measurable through the Singapore-Hong Kong trade route and the value of the Singapore Dollar against the US dollar. For example, exports to Hong Kong from Singapore are highly negatively correlated with the value of the Singapore Dollar per US dollar at -0.97. If the value of emerging market currencies were to slide against the US dollar further as the result of, say, further Chinese bond defaults, this would have an immediate negative effect on Singapore’s distributive trade across the region through Singapore because of the high correlation of its currency with both its trade generally and its trade with Hong Kong in particular.

It is imperative, therefore, that policy makers in Singapore continue to focus on the “Cog” rather than the “hub” approach to developing Singapore’s trade. As a trade cog, Singapore adds value to its imports through its innovation, particularly in its port technology to enable oil distribution, electronics and pharmaceuticals. As Figure 6 shows, there is a very high correlation between Singapore’s top four sectors and its currency which does not exist to the same extent In Singapore.

 

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Figure 6  |  Correlation between Singapore and Hong Kong’s top export sectors and their national currency against the US Dollar
Source  |  Delta Economics analysis

 

In the end it is this diversity that will limit the direct spillover effects from a slow-down in China. Singapore has built an innovative and entrepreneurial base and the impact on its trade is beginning to filter through into its exports, measured both by its value-added and the strength of its correlations with indices like the Nasdaq. As a cog facilitating trade across the region and beyond, this is more likely to shield it from less favourable conditions that potentially threaten growth during 2014.

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.

2014-04-28_TradeReturns_fig03_v01

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.

Asia Pacific

Most obvious declines in estimated and forecast trade are in China, Japan and Australia in Asia. Australia is highly dependent on China as an export partner, particularly for its iron ore and coal and, as China’s infrastructure construction boom slows and China’s economic growth also slows, Australia’s forecast export growth is also expected to fall. Japan’s export trade has failed to pick up despite the devaluation of the Yen against the US Dollar and this trend is likely to continue into 2014 with exports pretty much static compared to a mild growth in 2013.

Webcast 009 | Crouching Tiger, Hidden Dragon

Delta Economics is more negative now than it was about Asian growth. Our forecast for Asia’s export growth in 2014 has slowed from 6.1% growth last quarter to 5.3% growth now. This is part of a downward trend in Asia’s trade growth that we have been seeing take hold gradually over the past year. Holger Wessling, General Manager of DZ Bank AG (London), argues that this downward trend is due to a slow down in commodity growth and a decline in prices, negatively impacting trade finance. With the majority of trade finance centered within Asia, growth rates won’t be as positive as in previous years. Yet, with a lot of risks and a lot of potential volatility there is some light at the end of the tunnel. Growth and employment rates in North America and Europe are expected to pick up and growth in North-North trade will continue to strengthen.

Webcast 009 Author  |  Rebecca Harding  |  CEO

Don’t Cry for Me…

Why trade mistakes are hampering Latin American growth | In the context of the current Ukrainian crisis, the decision by Venezuela’s President, Nicolas Maduro, to suspend diplomatic and economic relations with Panama has barely registered. Trade between Panama and Venezuela is relatively small, worth an estimated US$ 1.2bn in 2013. Crude oil, which is Venezuela’s main export with a value of over US$ 2.6bn is not within the top 30 trade sectors between the two countries and therefore, on the face of it, the impact on long term policies to stabilise the Venezuelan economy may be minimal. Trade is highly volatile between Venezuela and Panama and Venezuela is more reliant on its trade with Panama for imports than it is for exports, as Figure 1 shows.

 

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Figure 1 | Estimated exports from Venezuela to Panama and imports to Venezuela from Panama, 2001-2014

Source | DeltaMetrics 2014

(Trade data between Venezuela and Panama contain a large number of zeroes thus data must be seen as indicative)

 

Second, and as Figure 1 also shows, the decision to stop trade with Panama potentially hurts Panama more than it hurts Venezuela. Venezuela was Panama’s largest export partner in 2013, although the US will take over from Venezuela during 2014. This calculation is ill-advised on several counts. For example, Venezuela relies heavily on the US for its oil exports. It is the US’s third largest importer of crude oil; it’s exports to the US of crude oil are ten times higher than for the second largest export partner – Germany. With inflation running at, reportedly, above 50% and with the fiscal deficit running at 16% of GDP, the country needs stability more than anything. Any tension with Panama has the potential to spill over into relations with the US and thereby affect its oil exports. The parallels with Ukraine’s situation are not drawn idly: street protests leading to a new government and increasing tensions with the US pose a risk of sanctions and this would not help Venezuela’s quest for sustainable economic growth.

Second, Venezuela is not amongst Latin America’s top 30 trade partners, and yet it is highly dependent on the region for its trade. As Panama’s canal grows so too will its trade both with Latin America, North America, the Middle East and with Asia-Pacific. Its port-to-port trade with, say Singapore is forecast to grow by 10% in 2014 alone and with Hong Kong by 8%. Any greater political instability in Venezuela will have the effect of destabilising trade between other countries in the region. We are already forecasting substantial drops in the trade between it and many of the Latin American countries and yet it has the scope to act as a trade route through to North America if it keeps its export routes with Panama open.

 

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Figure 2 | Venezuela’s export trade with Latin American countries (2014 values and change on 2013) compared to Panama’s extra regional growth.

Source | DeltaMetrics 2014

 

The fact that its largest export product through Panama is automotives demonstrates how important this trade route is potentially in integrating Latin American and North American non-oil supply chains. Before the lock-down of trade we were expecting Venezuelan exports of cars to Panama to increase by over 18% this year, albeit from a small base.

Venezuela’s exports to Argentina are forecast to grow by over 9% during 2014 but Venezuela would do well to learn from Argentina’s trade track record, especially on restricting trade with other countries. Argentina imposed punitive tariffs on importers in 2011 requiring them to export from Argentina the amount in value terms that they were importing. The effect on trade for Argentina has been to increase export and import volatility since, as illustrated in Figure 3.

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Figure 3 | Argentinian exports and imports, June 2001-February 2014

Source | DeltaMetrics 2014

Since mid-2011 when the first range of additional tariffs were imposed, Argentina’s trade has experienced greater volatility in its trade and in fact, trade seems set on a downward trend. The seasonal swings in trade, which were already greater than pre-financial crisis appear to have been accentuated in the years since with a particularly severe drop in 2011-12 as the tariffs started to take effect.

While Venezuela has not introduced tariffs, it has just suspended its trade with Panama, the lessons from Argentina in terms of regional contagion cannot be understated. Figure 4 is the same chart, Argentinian exports and imports, against the value of the Brazilian Real and shows clearly that the value of the Real in relation to the USD has deteriorated over the same time period.

2014-03-10_Don'tCryForMe_fig04_v01

Figure 4 | Risk of contagion: Argentina’s trade against the Real per USD exchange rate 2001-2014

Source | DeltaMetrics 2014, Bloomberg

It would be a mistake to say that Argentinian, or even Venezuelan trade directly causes a depreciation of the Real or other regional currencies. However, what Argentina’s economic and trade strategies have done, like other countries in the region, is make markets call into question the robustness and sustainability of economic performance and therefore to make them more bearish on the overall outlook as the collapse in the Peso and its knock-on effects to other Emerging Market currencies in January showed.

Venezuela’s trade is important to the region because of the link with the US and although they are not currently through Panama itself, the risk to that trade comes from geo-politics rather than trade economics. If it continues to suspend trade, then the US may impose restrictions on its imports. This could increase the downside risks to Venezuela’s trade forecast for 2014 and there is a clear risk for further contagion across the region. Perhaps like the Ukraine, this is a crisis that may start small but escalate to something bigger, particularly in economic terms. When it does, remember the lessons from Argentina, and don’t cry for me…..

Yen for a change?

Why devaluation of the Yen is unlikely to boost exportsShinzō Abe could not have been clearer in 2012: reversing the appreciation of the Yen since the start of the financial crisis in mid 2007 would stimulate export-led growth and assist a general objective of reflating the economy through higher import prices. Assuming a J-Curve effect, where the trade deficit would close after a short time-lag following a currency depreciation his view was that the policy would change Japan’s economic fortunes sustainably for the better.

Last week’s news that Japan’s trade deficit had widened was a confirmation that the J-Curve effect is not happening in Japan. In fact, the Yen has been depreciating against the US Dollar since October 2012, before Abenomics, and there is no sign in the Delta Economics forecast that there will be any pick-up in exports for the foreseeable future. Our forecast for Japan’s imports in 2014 has fallen slightly from 0.77% growth to 0.75% growth since September, but our forecast for export growth in 2014 has dropped from 0.14% growth in September last year to 0.01% growth now.

Some of this is because of the general failure of world trade to pick up pace in 2014. Japan is being particularly severely affected by this. Figure 1 shows Japan’s largest export partners and its forecast growth in 2014 with each.

 

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Figure 1 | Top ten largest export partners: forecast growth in exports 2014

Source | DeltaMetrics 2014

 

Trade with developed world partners is forecast largely to fall back this year with a particularly severe drop in trade with the US (-5.66%) and Germany (-1.31%). Even trade with its emerging economy partners in the Asia-Pacific region is not forecast to grow as quickly as we were forecasting in September 2013. For example, we were then forecasting that export trade with China would grow by 2.53% and we are now predicting somewhat slower growth at 2.42%.

The existence (or not) of a J-curve means that link between Japan’s trade and the value of the Yen per US Dollar exchange rate must be strong. Over the whole period, the correlation between the Yen in US Dollar terms and trade has been negative, at -0.48 which suggests both that imports may not always fall in line with expectations (rising when the currency depreciates) and that the relationship may not be strong enough for a J-curve effect. Figure 2 shows the trade ratio relative to the Yen-US Dollar exchange rate and demonstrates that the J-curve effect has not been working since April 2010.

 

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Figure 2 | Japan’s exports and imports against Yen-USD exchange rate, 2001-2014 (Yen per 1 USD)

Source | DeltaMetrics 2014, Bloomberg

 

Between June 2001 and January 2004 the Yen appreciated and exports declined relative to imports. A mild depreciation of the currency in Q1 2004 led to an increase in the ratio which continued until mid 2007 when the Yen started its more than five-year appreciation relative to the US Dollar. Exports fell relative to imports during this period. The rapid increase in trade in 2010 explains the sharp increase in the ratio from Q2 2010, despite sustained appreciation of the Yen, and was a consequence of catch-up after the global trade collapse in 2009.

 

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Figure 3 | Japan’s trade ratio (Exports divided by imports) against Yen USD exchange rate, 2001-2014 (Yen per USD)

Source | DeltaMetrics 2014, Bloomberg

However, what is really clear from Figure 2 is the sharp drop in the ratio after May 2011. This date is significant because it is 2 months after the Fukushima disaster. Exports relative to imports have not recovered since, despite mild depreciation of the currency from May 2011 and strong and sustained depreciation, arguably, since August 2011. In other words, the relationship between the Yen’s value and trade started to break down as early as 2010 when trade recovered from its global collapse.

The other striking observation from this chart is that the currency and trade are not especially correlated. There are few lags evident between a change in the currency’s value and a change in either exports or imports and over the period since the financial crisis, the correlation is relatively weak (-0.173) for imports and even weaker (-0.057) for exports. The negative correlation between imports and the Yen per US Dollar exchange rate points to a fact that as the Yen depreciates, imports will increase. Since 2011, this trend has become more obvious with the negative correlation strengthening to -0.606.

What might be behind this strengthening of the negative correlation with imports? Since Fukushima, Japan’s energy demand has been met increasingly by imports, particularly of Petroleum Gas, as illustrated in Figure 4. What this suggests is greater dependency on outside supply of energy and this is evidenced, not only in the increased imports of gas, coal and refined oil, but also in the fact that imports from Australia are forecast to grow by over 3% and from the Netherlands (which is a major oil and gas exporter) are forecast to grow by nearly 9% in 2014.

 

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Figure 4 | Largest exports and import products: forecast growth in trade 2014

Source | DeltaMetrics 2014

 

A steady increase in mineral fuel and iron and steel imports has been evident in the data since before the Fukishima disaster, however. Since the post-trade collapse recovery, it is imports of iron and steel, not energy, into Japan that have grown most strongly. Although demand for mineral fuels did rise after June 2011, the acceleration was not actually as fast as the previous two-year period from mid 2009, as illustrated in Figure 5. And, as the graph also shows, since December 2012, imports overall of mineral fuels have remained relatively static with a slight dip towards the end of 2013.

 

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Figure 5 | Top three import sectors relative to Yen-USD exchange rate, June 2001-Jan 2014

Source | DeltaMetrics 2014, Bloomberg

So is there any chance of export-led growth and a J-Curve effect? The decline in exports of Japanese cars of nearly 4% shown in Figure 4 is replicated at a sectoral level. Sector-level exports of vehicles, electronics and machinery, boilers and nuclear reactors seem impervious to changes in the exchange rate, as illustrated in Figure 6. Even during a period of strong currency appreciation exports rose and, since the depreciation in Q4 2012 exports have fallen.

2014-02-24_yenForAChange_fig06

Figure 6 | Japan’s Top 3 export sectors against Yen per USD exchange rate, June 2001-January 2014

Source DeltaMetrics 2014, Bloomberg

 

Assumptions about the J-curve and its impact on trade rest on a belief that policy can over-ride the power of markets to influence the value of a currency. Since the financial crisis, currency markets have sought a reserve currency alongside the US dollar and, until October 2012, the effect was the appreciation of the Yen versus the dollar. Abenomics has been successful in convincing markets that it is on a course to reflate the Japanese economy and set it back on a path of export-led growth. Recent data on the deficit suggest that the policy has had little effect so far. The ability of Japanese policy makers to over-ride the market will only last as long as the market belief in the policy is sustained. Delta Economics forecasts suggest that this might not be for very long and that any further depreciation, however desirable, might be because of lack of faith in Japan rather than a direct consequence of policy.