Why Abenomics breaks the golden rule

The falling yen underpinning Japan’s sharp stock market and exports uptick is not sustainable for the country and rubs salt into the wounds of its neighbours.


Abenomics, the name given to Japan’s experiment with monetary and fiscal stimulus, is designed to end chronic deflation, according to Shinzo Abe, the country’s prime minister. But there is yet little evidence of inflation. The world has merely seen a sharp devaluation of the yen. This devaluation is both unfair on other countries and unsustainable.

Since December the yen has lost about 25 per cent of its value against the US dollar and even more against the Chinese renminbi and the South Korean won. As a result Japan’s exports have accelerated and were responsible for almost half of its annualised 3.5 per cent growth in gross domestic product in the last quarter. The faster rate of exports has driven up expected earnings of large companies and, accordingly, the index of the Japanese stock market by 50 per cent. But core consumer prices remain lower than they did a year ago. Rather than raise expectations of inflation, Abenomics has simply generated expectations of further devaluation.

This type of recovery is unfair since it comes at the expense of Japan’s trading partners. In South Korea, Hyun Oh-seok, finance minister, last month said the won’s appreciation against the yen is a larger issue than whether North Korea launches a nuclear missile.

China has become the de facto shock absorber for Abenomics. For the past three years China’s trade surplus has been steadily decreasing as a share of its GDP, from more than 5 per cent to about 2 per cent. In terms of absolute value, the surplus has come down from about $300 billion to nearer $200 billion. Meanwhile, the nominal exchange rate of the renminbi against the dollar has appreciated by about 20 per cent since July 2010. Chinese inflation has been about 2 per cent higher than the US over the period, so the real exchange rate is appreciating faster.

Chinese exporters do not need a devaluation of the yen. Many Chinese products are in strong competition with Japanese equivalents – think of cameras and televisions. The yen devaluation is hurting producers of these goods. This is at a time when Japanese exports to China are rising because of relative quiet in the dispute over islands in the East China Sea.

A Japanese recovery based on a devaluation cannot last. The most important reason for this is geopolitics. Against the backdrop of quantitative easing by several central banks including Japan’s, China, Taiwan and South Korea are all facing the problem of currency appreciation. The falling yen is salt rubbed into their wounds. Nationalistic sentiments against Abe are high. Strong economic policy reactions from Japan’s neighbours are almost inevitable.

If the yen devaluation continues, China and South Korea may well have to interfere in the foreign exchange markets to stop the appreciation of their currencies. Trade disputes may emerge against certain Japanese exports. Finally, Japanese investments will be placed under increasing scrutiny.

Japan needs to return to the fundamental values of economics. Specifically, it should try to increase asset values through enhancing domestic economic activities. The most important element is higher capital expenditure by companies, which is missing despite the current boom in exports. This is an indication that Japan’s corporate executives do not believe that its currency appreciation is sustainable.

Most importantly, the Japanese government needs to implement its long overdue liberalisation of various regulations to allow businesses to invest freely. It needs to liberalise the labour market to allow companies to hire more workers; to enhance competition; and to encourage investment by small businesses via increased access to credit. Without this hard work, real economic activities cannot recover quickly and deflation will continue – despite the huge amount of money printed. This is a lesson the world has learnt through various financial crises and the ensuing hard-earned recovery. Japan must learn it too.

The writer is Mansfield Freeman professor of economics at Tsinghua University

Copyright the Financial Times 2013.

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