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FINANCIAL TIMES - Easy money cannot cure Japanese stagnation

Published:Wednesday | January 28, 2015 | 12:00 AM

By Henny Sender

Even as financial markets greet the European Central Bank decision to embark on massive asset purchases with rapture, the efficacy of such unconventional monetary policies in Japan grows ever more questionable, and the gap between the impact on asset prices and the real economy becomes ever more pronounced.

It should take a brave investor to buy Japanese government bonds today with yields on five-year bonds at 0.03 per cent and the 10-year at 0.24 per cent. It should take an even braver foreign investor to do so, given the weak yen.

Only those who are index investors would bother, since Japanese government bonds weigh so heavily in sovereign debt indices precisely because the issuance has been so heavy. But that does not matter. Demand from the Bank of Japan and other government-related institutions keeps prices artificially high and yields artificially low.

The cost of capital in Japan today is virtually nothing. Yet there is ever less evidence that low interest rates and a laughably low cost of capital are having any impact at all on investment and spending in Japan. Neither corporate Japan nor household Japan appears inclined to take advantage of easy financial conditions.

In November, machinery orders dropped 10.4 per cent after an almost 3 per cent fall in October, figures that were weaker than expected. That has led to fears that both capital spending and the export of capital goods, which has always been at the heart of the Japanese export machine, will prove soft once again.

Indeed, foreign machinery orders fell almost 19 per cent over the past three months of 2014, according to JPMorgan economists. Manufacturing PMI has also been flat.

Japan is well on the way to becoming the face of stagnation in the world today, though in some ways stagnation is not a concept that makes sense in a Japanese context. That is because Japan's growth model has never been about robust consumer demand, while the definition of stagnation includes both insufficient domestic demand and slack output compared to potential capacity.

Japan has not thrived because it has a population of happy consumers with the shop or die mentality so prevalent in the US. Instead, Japan was the original export-led growth model - and it worked beautifully for a while.

Its prosperity has always been based on low wages and a low return on savings in order to subsidise Japanese companies as they sell their products at far lower prices abroad than they do at home. In exchange for getting a relatively small share in the profits of their employers, though, workers were promised lifetime job security - at least at the most elite Japanese companies.

But the export model is no longer working for Japan. Today, the country has few of the competitive advantages that give it an edge at a time when China has vastly more economies of scale - and is rapidly moving up the value-added chain, and increasing its exports in spite of the relative strength of its currency.

The hope that an ageing population means fewer workers and therefore higher salaries is likely to prove vain. Japan's ageing workers lack the skills for a digital world and indeed for a globalised world.

Rather than trying to nourish domestic demand, reliance only on the first arrow of a cheap yen and low rates (painful for savers - especially for the elderly) and a tax policy that continues to favour corporateJapan at the expense of its households means private domestic demand will not come back any time soon.

Even the modest fiscal stimulus that was the government's second arrow has little multiplier effect and will be offset by the fact that taxes will go even higher in the future.

As the yen falls, Japanese tourists abroad have become an endangered species. Meanwhile, from the ski resorts of Hokkaido to Tokyo department stores, Chinese is becoming heard more frequently. The beneficiaries of current policies are foreign tourists, not the Japanese themselves.

Stagnation is not inevitable, though it is a lot harder to avoid given the demographics of Japan. But the Bank of Japan's policies will do little to reverse that stagnation. Moreover, buying shares simply because the government is allocating money to price support operations is not a terrific idea.

Fundamental arguments are a better reason to invest than the passing and artificial support of government institutions. After all, they have deep but not unlimited pockets.

(c) The Financial Times Limited 2015