- Japan can defeat deflation
- It’s the first arrow – not the third – that is the priority for Japan’s economic revival say Kashima and Cox of BNY Mellon Investment Management
HONG KONG 12 September 2014 - Two years after Shinzo Abe returned to political prominence, a growing number of observers are losing faith in “Abenomics”. The prime minister’s strategy to revive Japan’s economy relies on three “arrows”: monetary stimulus, fiscal pragmatism and structural reform. Many investors view structural reform, the “third arrow”, as the most important and the most disappointing. In a new white paper, Miyuki Kashima and Simon Cox of BNY Mellon Investment Management take a different view.
Head of Japan Equity Kashima and Investment Strategist Cox argue that the first arrow of monetary stimulus will banish deflation and in doing so, help Japan’s economy to revive. They differ from the skeptics who say an end to deflation is either improbable or immaterial. In their view, an end to deflation is both probable and consequential. They do not doubt that Japan suffers from serious structural shortcomings — and they welcome Abe’s efforts to ameliorate them with the “third arrow”. But the lack of structural reform is not yet the binding constraint on Japan’s growth. They argue the third arrow is nothing without the first.
In the white paper, Kashima and Cox debunk skeptics’ key concerns and offer the following opinions:
Inflation is an objective (and NOT an obstacle)
- The recent decline in real wages masks the strengthening demand for labor which will eventually bid up pay in line with prices. Japan has low unemployment, but sizeable underemployment. If demand remains strong, firms are likely to make better use of the talents of many of Japan’s wasted workers. Abenomics has already helped to boost labor-force participation among older men. Women are also joining the work force at a faster clip.
- The Bank of Japan reckons the economy has little spare capacity left. But its estimate of Japan’s growth potential is too conservative, in the view of Kashima and Cox. By the Bank’s own calculations, Japan’s economy could greatly exceed this putative limit without unleashing above-target inflation.
- Deflation makes it harder for monetary policy to fight downturns. As a result, Japan’s economy has been unusually crisis-prone, suffering three recessions in the four years before Abe returned to the stage. The end of deflation will restore a monetary-policy cushion beneath Japan’s economy.
Structural reform is SECONDARY to monetary stimulus (and NOT necessary to defeat deflation)
- Structural reform is necessary, but the pay-offs are gradual and incremental. Consolidating Japan’s fragmented farmland and cementing the Trans-Pacific Partnership, an ambitious trade agreement, will add only 1% to Japan’s GDP, according to recent estimates1 .
- Structural reform increases an economy’s productive powers. If spending does not rise in step, such reforms will add to the economy’s spare capacity, depressing prices. Without the first arrow, the third arrow of structural reform can make deflation worse.
Japan’s massive public debt IS manageable (and NOT the acute danger many fear)
- In 2013, Japan’s public debt was equivalent to 27 months’ worth of national output. But the government’s net interest payments were equivalent to less than four days’ output. Interest rates are low partly because government deficits are offset by large financial surpluses accumulated by corporations. If Abenomics works, these corporate surpluses will diminish, making government deficits less sustainable, but also less necessary.
- Deflation diminishes prices but enlarges the real burden of debts. Rising prices will make Japan’s public debts easier to sustain.
Investors have yet to fully recognize the potential of Japan’s homegrown recovery
- Despite the strong rally in 2013, the stock-market recovery still lags the earnings recovery by a wide margin, point out Kashima and Cox. The TOPIX would have to rise by 40% to catch up with the recovery in earnings per share.
- Global investors are still underweight Japan. The Government Pension Investment Fund, the world’s largest public pension fund is expected to increase its long-term holdings of Japanese shares2. In the first three months of 2014, Japanese individuals ploughed over 1 trillion yen into NISAs, the new tax-friendly investment accounts3.
- Previous stock-market rallies have largely reflected global developments such as the internet bubble at the turn of this century or the worldwide boom prior to the financial crisis. The potential in Japan’s domestic, inward-oriented economy—which accounts for the lion’s share of its GDP—may surprise many investors.
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This press release is qualified for issuance in Hong Kong and is for information purposes only. It does not constitute an offer or solicitation of securities or investment services or an endorsement thereof in any jurisdiction or in any circumstance in which such offer or solicitation is unlawful or not authorised. Any views and opinions contained in this document are those of the authors as at the date of issue; are subject to change and should not be taken as investment advice. Principle place of business of BNY Mellon Investment Management Hong Kong Limited: Level 25, Three Pacific Place, 1 Queen’s Road East, Hong Kong. Authorised and regulated by the Securities and Futures Commission. A BNY Mellon CompanySM
 “FY2012 Annual Report on Food, Agriculture and Rural Areas in Japan”, Ministry of Agriculture, Forestry and Fisheries
 “Japan’s GPIF to Cut Local Bonds to 40%, Survey Says” Bloomberg News, May 29th 2014.
 Financial Services Agency Weekly Review No.103 July 3rd 2014
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Christine Wood (FTI)
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