It’s all about context.
If my kids got one out of three answers right on a test, there would be a price to pay at home. The price would be steep and exceptionally unpleasant. As a hint, I’ve been known to assign bathroom cleaning duty for unacceptable grades. Hey, I might as well benefit from the punishment, right?
But in other areas, such as baseball, one out of three is pretty amazing. If a player consistently gets a hit one out of three at bats, then his average is 0.333 and he’s considered a stud.
When it comes to numbers, there is no question that the score is meaningless until it’s put in context. So when scoring the new Japanese Prime Minister’s economic reforms, we have to look at the entire picture, not just the first initiative. Unfortunately, when we consider all three “arrows,” the whole package comes up short.
To paraphrase the old rock song, “One out of three IS bad.”
Shinzo Abe regained power in Japan by promising dramatic economic and monetary reforms that would pull the country out of its 20 year deflationary slump. He talked about three arrows of reform, addressing monetary policy, business and regulatory reform, and wages.
When he was elected, he set about instituting his reforms by co-opting the Bank of Japan (BoJ), which had been at least nominally an independent entity. Now it is nothing more than a political tool doing the bidding of the Prime Minister.
So far, Abe has given the BoJ one big directive: Print yen… and lots of it. The goal is to drive down the yen’s value in the international markets, making Japanese products cheaper to other countries. At the same time, this policy makes hard assets at home (land, companies) more expensive because there is more yen floating around to buy them.
Another side effect is that imported goods are more expensive because of the lower exchange rate for the yen. So to sum up this arrow, the BoJ has been printing a zillion yen, has caused the yen’s value to fall by roughly 35% in six months, caused corporate profits from exports to soar, and made the stock market go up by 80% before falling back recently.
Of course, this policy of printing yen has also driven up fuel costs by an estimated 14% and food costs by 20% in some areas. It has also made imported gadgets more expensive.
That’s not so cool… which brings up Abe’s other arrows…
The second part of his policy was to revamp business regulations and labor markets to create more flexibility. Take a moment of silence to wish him well in this endeavor. There has been no movement here, and probably never will be.
That leaves his third arrow: Increasing wages. Recently Abe reiterated his desire to have businesses pay people more. That’s nice. What he left out is exactly HOW he intends to coerce businesses into paying people more. He hopes… hopes!… that as businesses earn more from exports they’ll see the benefit of passing along the extra money in the form of wages to employees instead of simply boosting corporate profits.
Hmmm. I think we need to say a prayer for this reform as well.
The short view of this three-pronged approach is that the first reform – printing yen with abandon – was fairly simple to accomplish because it only involved controlling one group, the board of the BoJ. Yes, it was an ugly thing to do, and yes, it ruins one of the checks and balances in government, but hey, it worked.
Unfortunately the other two reforms require corralling both Japanese Parliament and the business community, both of whom have a vested stake in the status quo. Those business regulations are there for a reason: they benefit special interest groups. And the labor market reforms… well, who exactly is going to get a bunch of 55-year-olds to accept that they can be fired from employment-for-life jobs?
As for wage increases, that would be very difficult to do because the benefits of a weaker yen are not evenly distributed… they accrue only to those who export. What about companies that import, like retailers and fuel companies? How do they raise wages? By raising prices? On a population that is currently having to pay more for necessities at a time when their own wages have not gone up?
Not a chance.
So the end result is that Abe took the easiest reform first, ran a victory lap before the race was half way through, and is now stuck dealing with the reality that the rest of his reforms are jammed in the mud.
Unfortunately, the devaluing yen genie is already out of the bottle, so we can expect this trend to continue, which should eventually bleed over into quickly devaluing Japanese Government Bonds and rising Japanese interest rates. Once this trend starts, it could be lights out for what is the third largest economy on the planet.
It won’t go bankrupt overnight… but eventually the country once known as Japan Inc. will have to undergo reorganization.
In this case, one out of three definitely stinks.
Ahead of the Curve with Adam O’Dell
Until late May, the yen was a one-way trade. You wanted to be short the currency… or safely on the sidelines. Yen buyers were simply run over. Any yen seller waiting for “better prices” got left behind.