Ishiba Deal With Trump Provokes Storm Of Opposition In Diet
Bessent Threatens To Lift Tariffs Again If Trump Unhappy With Tokyo
Source: IMF at https://tinyurl.com/2c56l84f Note: Column height shows the percentage change in predicted GDP from the January 2025 forecast; the percent figures in the data labels show the current forecast for GDP growth in 2025
From the Japan Times: “The bilateral trade agreement between Japan and the United States is a ‘win-win’ deal, the Japanese Prime Minister said... Japanese officials also claimed that Tokyo had avoided a nightmare scenario of a 25 percent tariff on exports of Japanese cars...But trade experts have expressed mixed reactions, with some arguing that the nation failed to secure a strong commitment from President Donald Trump and his trade team, pointing out that the U.S. promises are not made clear in writing.”
Oh, did I forget to mention that this article is reporting on the US-Japan agreement of 2019? While there was a formal legal agreement on some matters, Trump refused to put in writing his verbal promise to Prime Minister Shinzo Abe not to use a US national security law (Section 232) to impose tariffs on Japan’s auto exports. And yet, that is exactly what Trump did this year. He imposed a 25% tariff using Section 232 and has now merely stated that he will reduce it to 15% without specifying when. He has yet to issue the necessary Executive Order implementing that promised reduction, although Tokyo officials hope he will do so by August 1st. Even if he does do that, he can always issue a later order reversing himself. That’s because there is no formal, legally-binding agreement, just more verbal “promises” from Tokyo and Washington.
In fact, Treasury Secretary Scott Bessent has already threatened that the “deal” would be evaluated every three months, And if the President is unhappy, then they will boomerang back to the 25% tariff rates, both on cars and the rest of their products. And I can tell you that I think at 25, especially in cars, the Japanese economy doesn’t work.” That boomerang was never even discussed in the negotiations.
The consequence is a ruckus in the Diet from all parties, including some members of the ruling Liberal Democrats (LDP) opposing the deal on the grounds that Trump may once again renege.
The Land Of Broken Promises And The Broken-Hearted
Today’s outcome is far worse than in 2019. The two sides have not even issued a joint statement. Rather, each has issued “fact sheets” which differ quite markedly. For example, in Tokyo’s fact sheet, there is no promise from Japan to buy 100 Boeing jets as Trump’s “fact sheet” claims; no promise to make $550 billion in new investments, just a promise to issue government loans and guarantees if private Japanese companies wish to up their investments; no promise to let Trump decide on the investments and give the US 90% of the profits.
Moreover, unlike in 2019, there is no intention to eventually issue any formal pact. Moreover, unlike in 2019 when Abe pressed for a written promise, Prime Minister Shigeru Ishiba also wanted no formal agreement. That’s probably because such pacts must be ratified by the Diet and, with the LDP-Komeito coalition having lost its majority and such great distrust of Trump, any attempt at ratification risks failure. Ishiba might not even be able to get the votes of all LDP Diet members. Sanae Takaichi, who as leader of the former Abe faction is trying to unseat Ishiba, stated, “Since there is no agreement document, we do not know what will really be secured."
Democratic Party for The People (DPP) leader Yuichiro Tamaki initially supported the trade deal. But he withdrew support when he realized there were no legal constraints on Trump. This came about when, at a July 25th meeting with the leaders of the opposition parties, Ishiba said he “did not plan to issue a joint document based on the U.S.-Japan agreement.” Following that meeting, Tamaki told reporters, “Since the target of implementation is not clearly stated in the document, there is a feeling that President Trump will return to 25%. I would like to withdraw my original comment that ‘appreciated’ the outcome of the trade talks.”
Former Prime Minister Yoshihiko Noda, now the leader of the biggest opposition party, the Constitutional Democrats (CDP), told reporters, “If you do it without written documents, you may be shaken by the way of interpretation by the US... I fear that the difference in interpretation between Japan and the U.S. will become a minefield.”
A Falling Tide Sinks All Boats
Trump’s trade war does not benefit anyone, not even the US, although it may temporarily help Trump politically.
In a just-released new economic forecast, the International Monetary Fund predicted that Japan’s GDP growth in 2025 and 2026 would be reduced by 40% from the pace it had predicted back in January, just 0.7% (instead of 1.1%) this year and 0.5% next year (instead of 0.8%). American growth would be 30% smaller in 2025 and about the same as predicted in 2026 (by contrast, the Yale Budget Lab expects the hit to US GDP to be just as severe in 2026 as in 2025). Among the hardest hit would be Korea, with 60% less growth this year, and Germany, with 67%. China, on the other hand, is expected to experience slightly higher growth (see the chart at the top).
Uncertainty is the great enemy of business investment. Why invest if you are less certain about the demand for your products in the future? Consequently, across the world, Bloomberg estimates that investment next year could be half as much as was previously forecasted (see chart below).
It remains to be seen whether and to what extent the damage to the US economy will lead to a backlash against Trump, forcing him to backpedal somewhat. The Yale Budget Lab predicts that higher prices will cause the average household to suffer a $2,000 loss in income. Less affluent voters—who comprise much of Trump’s base—will take a bigger hit in terms of the share of their income. Moreover, while manufacturing output is expected to increase, most of that growth will likely occur in lower-skilled products, where the US finds it challenging to compete. Advanced manufacturing is expected to be 2.8% smaller in the long run, partly due to the increased cost of its inputs. Finally, the manufacturing gains will be more than offset by drops in the rest of the economy.
As for Japan, economists there agree with the IMF’s projection that GDP growth in 2025 will be reduced by about 0.5 percentage points. The most pessimistic of them, Daiwa Institute of Research economist Daiwa's Kugo Shotaro, says the tariffs may reduce Japan's GDP by 1.1% this year and as much as 3.2% by 2029, assuming that the tariffs continue.
“The Lesser Evil” Theory, Relying On the Weak Yen
So, why did Tokyo acquiesce to such a flawed arrangement? Here is the thinking I gleaned from some conversations as well as press reports:
1) This was the best deal we (Japan) could get from Trump; he was determined to apply hefty tariffs.
2) A bad deal is not as bad as no deal. Up to a point, uncertainty paralyzes business activity even more than a bad outcome, as seen in the plummet in business investment in the chart above.
3) Tariffs of 15% are not as bad as 25%. At 25%, the profits of Mazda and Subaru might have been completely wiped out. At a 15% tariff, the profits of Japan’s seven automakers will decline by “just” 25%, on average, instead of 45%.
4) The exceptionally weak yen allows Japan’s most prominent companies to absorb much of the harm (details below).
5) Yes, Trump could break his word again; that’s the world we (Japan) live in, and we have to adapt to it and try to reduce our vulnerability. Even when Trump signs a legally binding pact, as in the case of the 2019 agreement with Japan, he can de facto abrogate it, as he did this year.
6) The Trump tariffs may be here to stay. “Once tariffs are imposed, they are unlikely to be reduced by the next administration, and I believe they will become permanent,” said Nakanishi Takaki, head analyst at Nakanishi Automotive Industry Research
7) Part of Japan’s adaptation is to become less dependent on the US. The chairman of Keidanren, Yoshinobu Tsutsui, declared, “I strongly recognize the need to create a resilient economic structure that does not depend on the United States and China, subject to external pressure due to the tariff policy.” Currently, 40% of Japan’s exports go to these two countries.
Weak Yen Allows Big Exporters To Absorb Much of the Pain
Giant companies dominate Japan’s exports, and the weak yen has boosted their profits so much that the biggest of them can still make profits, albeit smaller ones, with a 15% tariff. Hence, some are choosing to absorb the tariff in order to avoid rising dollar prices and losing customers. Toyota is a prime example.
Of Japan’s 17,000 manufacturing exporters, just 10% (1,700) account for 95% of all Japan’s exports, while just 1% —a mere 170 companies—account for 76%. Most of them are among the top 1,700 manufacturing corporations with capital of at least ¥1 billion, or a few hundred with capital of at least ¥10 billion. On average, these biggest exporters can be profitable with the yen at ¥123 per dollar (see the rightmost column in the chart below). The top third of these giant exporters can be profitable with the yen at ¥110 or even stronger (see dark blue square in the rightmost column).
Source: https://www.esri.cao.go.jp/en/stat/ank/r6ank/r6ank_tables_listed_companies.xlsx Note: Only exporting companies on the stock market are included. The blue columns show the breakeven rate for the average firm in each size category. The dark blue square shows the one-sixth of firms that can be profitable with the yen at a much stronger rate. The dark blue diamond shows the one-sixth of firms that need a much cheaper yen to export at a profit. See text for further explanation.
A 15% tariff requires a yen that is 15% cheaper for exports to the US in order to reach breakeven. For the giant exporters with an average breakeven rate of ¥123, the 15% tariff would be equivalent to a breakeven rate of ¥141. Today, the yen is ¥148.5, so they are okay. For the most efficient of these giants, who can be profitable with the yen at ¥110, a 15% tariff is equivalent to the yen of ¥126 of cheaper. By contrast, half the firms in the two middle would need a yen at ¥147-148 or cheaper to avoid losing money on their exports to the US. Most of the smaller publicly listed exporters will lose money on US-bound shipments. Many of the exporters will reduce their shipments to the US if they cannot afford to lose that much money.
So, while a significant majority of Japan’s exports are sold by the very largest and most efficient firms that can endure the 15% tariff, lots of listed corporations are far more vulnerable, and they sell a substantial fraction of Japan’s exports.
I’m a big fan of creative destruction, but Trump’s trade war is going to unleash an awful lot of “destructive destruction” in Japan, the US, and the rest of the world.
P.S. Courts in the US are still determining whether Trump’s “declaration of emergency” to impose the “reciprocal tariffs” portion of the new tariffs is legal. A new hearing is scheduled for Thursday. The case will probably go to the Supreme Court. As of today, the tariffs are still in place.
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Thanks for putting the situation into perspective.
Without a written agreement, it's hard to imagine how things will go smoothly. Of course, even with the 2019 agreement, Trump simply reneged on his promises, as you noted.
Is the current agreement really a good deal for Japan?
Why wouldn't the Japanese government threaten to play hardball by selling their U.S. treasuries and imposing reciprocal tariffs, including on services?