Things have calmed in Japan since the catastrophe of last March. Investors also have worries elsewhere: the European debt crisis, the US Fed’s efforts to mime control, China’s slowdown or tensions in the Persian Gulf. But the current calm surrounding Japan could hide some nasty issues.
Since Japan’s housing and stock market bubbles burst in the early 1990s, Japan has hovered in a deflationary stagnation, exacerbated by its demographics. Interest rates are stuck at zero and the public debt-to-GDP ratio, at 240%, is twice that of Italy. For many observers, Japan is prototypical of what developed economies such as the Eurozone, US or UK are poised to become.
So, nothing new in the Land of the Rising Sun? Think again. The Japanese trade balance for November recently showed its ninth consecutive negative monthly reading. The last bad streak of such length came between August 2008 and March 2009, during the global recession, and before that in 1980. What can we say about this? Optimists would argue that a global rebalancing is occurring; Japan, like China, Germany and the oil-exporting countries, usually shows a structural surplus and is now correcting that. Others say Japan has not yet recovered from Fukushima, roughly 90% of its nuclear plants are currently not working and it needs to compensate that by importing more oil. Hence, the pattern will reverse once the Japanese energy supply problems are solved.
Pessimists seek other explanations for this unusual data. We see three, which if true, point to a bleak future for Japan and also for the rest of the world economy: the strength of the Japanese yen, the weakness of Chinese demand, and diminishing Japanese savings.
The strength of a currency usually helps to explain trade patterns. In our case, the Japanese yen has risen dramatically in recent months. It is now at an all-time high against both the US dollar and the euro. Expressed in trade-weighted real terms, it is 10% above the 1995 peak, when, however, the trade balance was strongly positive. In our view, this high exchange rate and the persisting trade deficit give credence to those who press the Bank of Japan to adopt an exchange rate floor for the yen. Hence, we would not be surprised to see much more Japanese currency intervention in the future.
Lack of demand for exports from abroad also causes trade deficits. Growth appears to be faltering in China, the prime importer from Japan; the Japanese trade deficit may reflect this. We might be seeing a replay of what happened in 2008–2009.
Our last explanation for Japan’s negative trade figures is the most bearish. We can view a trade deficit from two angles, the first being international: exports minus imports. The second, inter-temporal view, looks at domestic production minus domestic demand. A negative trade balance thus expresses the fact that a country consumes more than it produces, or that it is indebting itself abroad. If this were the main cause of Japan’s deficit, then running a public debt at 240% of GDP with interest rates at almost zero would be quite dubious.
The aging of the Japanese population has been accompanied by a falling rate of private household savings. If the government can no longer rely on Japanese private savings to absorb its deficits, then it will need to find international investors. But these are not likely to lend willingly to such a heavily indebted country at zero interest rates. Hence, the only alternative Japan might have is to monetize its own public debt. Since Japan is prototypical of what is now happening to many developed economies including the US, its trade deficit could also herald what we can expect as the endgame of the financial crisis of 2007: debt monetization followed by massive inflation.
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