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Video: Weakest Real Yen In Half Century Reflects Deterioration of Japan’s Competitiveness
In The Short Term, Tokyo's Only Option Is To Pray For Lower US Inflation
This video (URL at the bottom) presents a panel discussion on the yen, Japan’s competitiveness and growth potential, and Bank of Japan policy, It was held at the Foreign Correspondents Club of Japan (FCCJ) on November 11th. The other panelist, Hiromichi Shirakawa, Japan Chief Economist at Credit Suisse Securities, and I were pretty much on the same wavelength. Here’s the gist of my presentation:
In the short term, Tokyo has no good options to deal with the yen’s weakness. That’s because, in the last year and a half, the single biggest factor in the yen’s weakness has been the gap between American and Japanese interest rates. As we all saw yesterday, when the ¥/$ strengthened from ¥146 to ¥139, American inflation figures, and consequent interest rates, have more impact on the yen than anything the Bank of Japan (BOJ) can do (see chart below).
Source: Federal Reserve, Wall Street Journal
While there are calls for the Bank of Japan (BOJ) to raise interest rates, a quarter-century of near-zero interest rates has turned Japan into a low-interest-rate addict. With 16% of all loans charging interest of less than 0.25% and 70% less than 1%, a host of companies would suddenly become insolvent if forced to pay substantially higher rates. Currently, the economy is too fragile to raise rates enough to make much of a dent in the current gap of 3.5 to 4 percentage points.
Weak Yen Reflects Weakened Competitiveness
More importantly, the yen’s historic low reflects, not just differences in monetary policy, but a dramatic deterioration of Japan’s real competitiveness. Here’s the evidence for that:
Firstly, the “real” yen is weaker than it has been in a half-century, at the dawn of the floating currency rate system. (The real yen adjusts the rate of the yen against all trading partners and adjusts for the difference in price trends in Japan and other countries. A lower number means a weaker yen. See chart below).
Source: Bank of Japan at https://www.stat-search.boj.or.jp/index_en.html#
Secondly, at any particular gap in interest rates, the yen is about 20 points weaker today than it would have been 10-to-20 years ago (note the blue downward arrow in the chart below).
Source: Author calculation based on data from Federal Reserve, Wall Street Journal
Thirdly, even with a weaker yen, Japanese companies still find it hard to compete. Japan used to run regular trade surpluses even when the yen was much stronger than today. But, for more than a decade, Japan has been running chronic trade deficits, even though the real yen was 30% cheaper in the last decade than it was during 1994-2012. In short, Japanese companies are now competing on price, rather than product superiority, and are like a deconditioned person on an accelerating treadmill who has to run ever-faster just to keep up (see chart below).
Source: Cabinet Office at https://www.esri.cao.go.jp/jp/sna/data/data_list/sokuhou/files/2022/qe222_2/tables/gaku-mk2222.csv
Fourthly, even former superstar industries like electronics now run chronic deficits. Even worse, these companies have trouble competing even when they produce in other countries. Despite a 40% surge of global electronics sales from 2008 to 2020, every one of the Japan’s top ten electronics hardware manufacturers saw its global sales slump during that period. Moreover, from 2010 to 2020, total global sales of all Japanese electronics firms plunged 30%.
Finally, on average, improvement in Japan’s real (price-adjusted) trade balance has contributed a meager 0.1% to Japan’s real GDP growth per year, an amount equal to a rounding error. That’s no higher than it was when the yen was much stronger (see chart below).
Source: Cabinet Office at https://www.esri.cao.go.jp/jp/sna/data/data_list/sokuhou/files/2022/qe222_2/tables/gaku-jk2222.csv
Weak Yen Makes Japan Even Weaker
The weak yen not only reflects Japan’s economic travails, but it is also adding to them. The BOJ is wrong when it claims a weak yen provides a net benefit. It’s the Goldilocks principle: a currency that is too weak causes as much damage as one that is too strong. While the weak yen is adding little to Japan’s topline GDP growth, it is seriously reducing real wages, consumer purchasing power, and the profitability of small and medium companies, by causing big price hikes in import-intensive food and energy. 90% of the rise in prices over the past 18 months, and in the past decade, has come in food and energy. Prices in the rest of the economy have barely risen (see chart below).
Source: Statistics Bureau at https://www.e-stat.go.jp/en/stat-search/file-download?statInfId=000032103842&fileKind=1
That kind of inflation transfers income from Japanese households to foreign producers. It also indirectly transfers income from Japanese households to Japan’s multinationals. Here’s how the latter works. Japan’s consumers pay more of their income to foreign producers. Some of that comes back to Japan’s multinationals because they can export more and because their profits on overseas affiliates generate more yen when those profits are repatriated.
The result of that income transfer is that consumption in 2019 (before Covid) was lower than it was in 2014 and, as of July-Sept. 2022, due to a slow recovery from Covid, it’s even lower
.Source: Cabinet Office at https://www.esri.cao.go.jp/jp/sna/data/data_list/sokuhou/files/2022/qe222_2/tables/gaku-jk2222.csv
What’s The Solution?
What is required are reforms that improve Japan’s underlying efficiency, once more making Japanese firms competitive on the global market.
Perhaps the one bit of good news in this picture is that the yen shock is sounding the alarm. The question is whether policymakers can really hear them and understand what they mean. By the end of the year, the Kishida administration is set to issue a five-year plan that could do a lot to improve the situation if lofty goals about income distribution and nurturing startups are turned into concrete policies. Unfortunately, recent conversations with policymakers in Tokyo suggest that, while a few of the necessary positive steps will be taken, they will not be nearly enough to turn the ship around.
Here’s a video of the discussion. (It seems to start in the middle, so move the cursor to the beginning.)