Japanese equity and real estate markets had risen sharply in the build up to the early 1990s, as Japanese banks lent without much regard to the quality of the collateral or the borrowers ability of borrowers service debt. This caused equity and real estate prices to rise, leading to the boom in asset prices and increased leverage, which further fueled consumption, mal-and-over investment and growth. As the Bank of Japan (BoJ), which had previously held rates low, started to raise rates in the early 1990s, the elevated equity and real estate prices proved unsustainable and the bubble eventually burst, sending the economy into free-fall.
A view back to 1985, highlights the signing of the Plaza Accord in 1985 as playing a key role in the saga, as an agreement was made between the UK, France, West Germany and Japan to intervene in the currency markets in order to depreciate USD against JPY and the West German Deutschemark (DEM). The unintended consequence was to cause a sharp appreciation of JPY from around USD/JPY 200 in 1985 to around 135 in 1990, which harmed the competitiveness of Japan's export driven growth model. During the Lost Decade, Japan´s GDP growth was only 0.9%. While real GDP has been lukewarm since the crash, nominal GDP has been flat for close to two decade due to the combination of slow real economic growth and stagflation, followed by deflation. In terms of Real GDP growth, Japan fell from among the highest of all G7 economies, to the lowest between 1990-2011.
A further consequence has been that Japan´s global role has diminished since the mid 1990´s. Its share of global output has nearly halved since the mid 1990s, while competitors like China have expanded dramatically. Also, Japan´s share of imports and exports has also suffered considerably, despite opening up its economy further to external investment and international trade.
2008 - 2012: Abenomics -The Final Straw?
The US Sub-Prime Crisis of 2007-2008 which lead to the Global Recession had a big impact on Japan. The country is yet to recover from the period, and while its economy initially began to rebound quite quickly from its crisis bottom, the 2011 Earthquake and Tsunami caused enormous damage before the recovery could properly take place. The devastation hit production, the supply chain and energy supply, with rolling blackouts in Tokyo a common energy saving occurrence at the time.
Regarding currency strength, the 2008 crisis saw investors flock to JPY as a safe haven currency, forcing it to strengthen considerably against the dollar and the euro. The Earthquake and Tsunami in 2011 saw an influx of capital inflows to help with reconstruction costs, forcing USD/JPY to near record lows around the mid 70s. This in turn made struggling Japanese exports even less competitive in an increasingly crowded market space. All the while, the global recession continued to hamper global demand for the advanced manufactured durable goods like vehicles, machinery and electronics that Japan specialises in.
Nevertheless, despite the economic decline, the standard of living remains high in Japan,. However, persistent deflation and poor economic and employment prospects have combined to put added pressure on younger generations who are in turn having less children and suffer from the some of the worlds highest suicide rates. The lack of new births is set to have a deeper economic impact as a looming pensions crisis waits on the horizon. Further, where western nations have addressed this challenge by opening up their borders to immigration to rebalance their sources of labour, Japan has not and remains an insular society as a whole. Worsening economic prospects and a shrinking labour force have in turn conspired to see a decline in Japanese Real Wages and worsening general bargaining positions for Japanese workers, which has led to an increase in inequality.
Since the 1990´s, the Japanese Government has attempted to combat its economic woes by running significant deficits, with extremely elevated ratios of general government net debt to nominal GDP. While the policies have had mixed success, helping to avoid depression at times, they have not been able to overcome the nations stagflation, instigate growth or help improve the jobs markets. The political elite in Japan have been quite divided on how to tackle the problem, with the LDP who had ruled uninterrupted since the end of the war, splintering in 2009 following a period of short term reigns of Prime Ministers and cabinet ministers. The DPJ eventually took office but following an extended period of policy paralysis, public confidence was at a low.
In late 2012 with upcoming Japanese elections, Shinzo Abe emerged as a contender for the leader of the LDP. He proposed a radically aggressive combination of fiscal and monetary policy, alongside private sector investment, since dubbed the “Three Arrows”. These arrows represent an attempt to finally break Japan´s cycle of deflation once and for all. After he captured the LDP nomination, and then subsequently won the election, his manifesto became known as “Abenomics” by commentators. From the start of his election campaign, the reaction in the foreign exchange market can be visibly noticed with USD/JPY rapidly rising from 77 to a high of 96.70 seen in March 2013.
“Abenomics” in simple terms is a comprehensive set of economic policies aimed at ending deflation. Since the formation of the Abe government, the “Three Arrows” of policy have been prioritised and some enacted. Many commentators believe that Abenomics have the potential to influence Japan´s economic growth potential and future growth trajectory via a combination of financial and structural reforms as well as short term stimulus measures. Abenomics views deflation as a drag on economic growth, therefore meaning that households have less to spend on clothes and meals. Further, Prime Minister Abe successfully put immense political pressure on the BoJ to adopt a 2% inflation target, at times under the threat of changing BoJ Law. The departure of Governor Shirakawa from the BoJ and the appointment of Haruhiko Kuroda to the roll has significant implications in that Kuroda was previously a Ministry of Finance (MoF) official who has been vocally opposed to BoJ policy in the past. Traditionally, a firewall has existed between the two bodies, with officials not crossing the divide.
While there were public commitments to avoid competitive currency devaluation at the recent G7 and G20 meetings, all focus was understandably on any mention of Japanese developments. However, while some objections may have been noted in private, nothing was highlighted in the official communique, as there was a bottom line understanding that a Japanese recovery is ultimately good for the global economic recovery. However, while in laymans terms, a weaker Yen is good for exporters, many feel that unless managed properly, it could have an adverse effect on the economy via an expansion of the trade deficit or a deterioration of the Japanese terms of trade. For Abenomics to be a success, analysts will be watching for an abandonment of ingrained expectations about deflation and a subsequent improvement in growth expectations, a self-sustaining increase in private sector economic activity, namely growth without fiscal expansion, and finally fiscal reconstruction, the easing of fiscal risk. If confidence in economic growth improves and translates into an improvement in corporate earnings, a subsequent increase in employment and wages should follow, leading Japan back onto the path to recovery.