Abenomics Drives Japanese Yen Down As China Tension Rises

Abenomics has been praised of late for providing some momentum to the Japanese economy. Two diverging economic indicators supported and attacked the effectiveness of the Prime Minister Shinzo Abe economic plan.

Japan exports rose 16.5 percent in October from a year ago. The currency has devaluated close to 20% this year after the start of Abenomics in March. The japanese economy has only partially benefitted from the lower currency as the stock market and exports have risen.

The flipside of that is that Japan is importing energy and food at a higher rate, which in fact have turned the country famous trade surplus into a deficit. Imports in the same period have risen 19 percent.

Gross Domestic Product in the third quarter was stronger than expected at 1.9%. Compared to the previous quarter gain of 3.8% it was a disappointment. The government of Shinzo Abe focused his efforts on inflation. Japan has been caught in a deflationary environment for over two decades. Importing inflation via a falling currency with energy and food prices denominated in foreign currencies have boosted the CPI.

Abe has laid out a three-part approach to fixing the Japanese economy via three “arrows”: monetary stimulus, government spending, and structural reforms. The first part of the Abe plan seems to be working. Boosted by the Bank of Japan the monetary policy has driven down the price of the currency and helped inflation rise. The other two parts of the plan have failed to gain traction. Wages need to go higher in order to keep up with inflation or consumers won’t spend. Structural reforms need to be added to unlock the labour and direct investment market.

The GDP growth experienced this year will have some challenges going forward if Japanese corporations don’t start spending more aided by reform changes in the labour market. Corporates continue to enjoy the benefits of a weak yen, but as in other G7 economies they are not reinvesting or hiring. Given the state of Japanese demographics it will also be interesting to see how seniors and retired persons take to this new term “inflation” when their income remains the same.

The monetary policy plans from the US Federal reserve support further Yen weakness, but so far the Fed’s taper has been all talk and little action. Expectations are rising that with a new Chairman at the Fed as soon as the end of the year can mean a late 2013 taper or an early 2014 reduction of bond-buying. This would be good news for the Japanese government’s plan as it will drive down the JPY below the current 102 USD/JPY level.

Shinzo Abe is no stranger to conflict with China. As part of the country’s right wing he has been accused of denying the crimes that the invading Japanese army during the Korea and China occupations. This animosity still persist and has caused boycott of Japanese products in China. The fact that Japan’s main partner the US has also deep financial, commercial and political ties to China has given Abe the urgency to change the Japanese constitution.

The current Japanese constitution does not allow Japan to form an army. There are certain loopholes that permit the existence of the Self-Defense Force, but given the current geopolitical strife in the area its clear Abe wants to reduce its dependency on US armed forces. Specially if he can replaced it with a Japanese army to avoid Chinese intimidation.

Over the weekend China announced a new air defense zone. The air space includes a group of island that are in contention between China and Japan. The US has backed Japan in its claims, and denounced the recently modified air zone. China for its part, has already reported US violations to this new air defense zone. This type of incidents will only continue going forward with political and economic repercussions for two of the major economies in the world.

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