UBS On Japan - Are You 'Abe'liever?

Tyler Durden's picture

Authored by Duncan Wooldridge via UBS,

We totally get why many are excited by the recent cyclical improvement in the Japanese economy. However, just because industrial production is turning up on the back of exports and 1Q GDP grew more than expected doesn’t mean Abeconomics is working. Our colleague, Paul Donovan, correctly pointed out these improvements occurred before the Bank of Japan aggressively started to ramp up base money and there’s been no structural reform to date. Hence, most of the improvement in Japan is probably best described as a standard cyclical improvement in the aftermath of very depressed growth that was also heavily influenced by last year’s downturn in global trade. Recent positive momentum in the economy will likely be sustained for a few more quarters and then of course later this year and early next year consumption should accelerate ahead of a consumption tax hike scheduled for April 2014. So for Abe-believers there will be fuel to support their optimism. However, once you move beyond that and think about what comes afterwards things look more challenging.

Can Japan sustainably lift aggregate demand above supply? If that cannot be done then it’s hard to see deflation resolved in a fundamentally positive way. Aggregate demand is heavily influenced by demographics and exports. We published chart 1 recently and it shows that historically the growth rate in Japan’s labour force is an excellent indicator for inflation. That’s because the growth in the labour force affects the level and growth of aggregate wages since total wages equal the number of workers multiplied by wages per worker. That has an affect on consumption and aggregate demand. We did some back of the envelope calculations that suggest even with wages per worker growing by 1% the aggregate wage level might not rise.


Meanwhile the consensus is busy writing report after report on what Japan means for Asia. In our view, the more interesting question is what does Asia mean for Japan? Exports will play a vital role in Japan’s efforts to raise aggregate demand above supply. So here’s the problem. We’ve argued consistently that Asia is 5 years into building a credit bubble in an effort to substitute credit-led domestic demand to offset trend weakness in external demand.

Our central thesis back in 2009 was that Asia’s willingness to increase leverage would be helpful to growth, asset prices and profits in the region, and by extension intra-Asian trade. But we also argued that with time and higher leverage Asia’s credit-led growth would suffer from diminishing marginal benefits of taking on more debt. That is arguably where much of the region is today and partly explains why Chinese growth is beginning to disappoint expectations.

It’s highly likely that Asian economic growth a few years from now will slow significantly as the region’s credit-led growth policies become progressively less effective and produce untoward headwinds for growth. After all, there is always a significant slowdown in growth waiting for you on the other side of any aggressive credit expansion. The problem for Japan is that over 50% of her exports go to Asia. Hence, improving exports are currently helping cyclically but a slowdown in exports – led by weakening Asian demand -- a year or so out is likely. A slowdown in exports to Asia along with a shrinking Japanese consumer base will make it more difficult for Japan to sustainably inflate aggregate demand relative to capacity or supply.

This is especially true since capacity is sticky and Japan arguably has too much capacity. A country’s capital stock, along with labour, allows it to provide goods and services to the population; i.e., to meet aggregate demand. Japan has the highest per capita capital stock in the world despite having a shrinking population that is expected to accelerate over the next few decades. The only country in our sample that presently looks similar to Japan is Germany.

However, that’s not an apple to apple comparison. First, it’s true that Germany’s capital stock is high, far higher than the US, and its population is shrinking. But in Germany’s case its internal demographics are far less important because it is part of the European Union and importantly labour can move freely between Germany and other EU members. Hence, even though Germany’s population is shrinking its labour force continues to grow unlike Japan, and as we mentioned earlier that affects aggregate demand. Secondly, Germany shares the same currency with its major trade partners, which gives it a competitive advantage in many respects.

So we sum it all up like this. There are definitely signs that Japan’s economy are improving cyclically. However, structurally demographics remain a major headwind to raising aggregate demand. We feel many investors have not yet considered what slower growth for Asia will mean for Japan in the medium term. This will make it more difficult to raise aggregate demand above supply since capacity is sticky and Japan already has excess capacity.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
idea_hamster's picture

In Chart 3, Japan at least has company with Germany.

WTF is China doing all alone?!

PiltdownMan's picture

How about nooo. You crazy Swiss bastards. The Japanese sovereign curve is GOING THE WRONG WAY!! See this guy's charts.

Gidas19's picture

Well according to WSJ, yen is a safe-haven I guess... Now im really Abeliever...

JenkinsLane's picture

Word is Kyle Bass is going to sing a cover version of this on the karaoke machine at this year's Hayman Capital Christmas party.

fonzannoon's picture

I heard someone on here yesterday say that UBShit was defaulting on some gold deliveries. Any truth to that?

kito's picture

i enjoy thai food long as nobody defaults on my chicken pad thai, im ok......................................

fonzannoon's picture

something about the peanuts with the pad thai....yuck.

kito's picture

im not a fan of the bean sprouts that is served on top of the noodles....but i dig the peanuts!!!!.............

Cognitive Dissonance's picture

Forget Cyprus. Is Japan the (real) template?

disabledvet's picture

let's start with something we DO know and go from there shall we. THEY HAVE A PROBLEM "and firing up all those nukers will only make it worse." i know of no plan to fix that problem other than "export there way out of it" and that says to me "currency crisis." we know what happened to Russia after their "problems on the night shift." go ahead and "formulaize" that. these information guys aren't interested in the way you think things work...they want HARD DATA. the trade deficit is worsening...the currency getting clocked. "get out while you still can."

bank guy in Brussels's picture

Bravo to Japan for trying, at the very least

If they start the big global meltdown, better sooner than later

And Japan should get applause, too, for 23+ years of keeping people in jobs and avoiding the worst ... unlike in the USA and Southern Europe

We should all wish that Japan WAS the global template

In Japan they made it a priority not just to prop up the banks, but to keep people in jobs and employed ... they never went for the mass unemployment 'cure' mauling their own people ... they avoided depression and social tragedy, like in Greece and America

Whatever happens in Japan, burdens will be shared ... in the USA and southern Europe, not so much ...

LawsofPhysics's picture

Something about a "homogeneous culture" comes to mind.  How are meat cleavers selling in the E.Z. these days?  Oh wait...   ...nevermind.

LawsofPhysics's picture

If only humans didn't require food and energy, to actually do everything.  Stupid fucking sheep.

q99x2's picture

Replace the Yen with BitCoin. Replace the Japanese with open source software. Live long and prosper.

Fuh Querada's picture

Spain, Portugal, Greece and Ireland have great demographics!

They trynna catch me ridin dirty's picture

The Keynesian cargo cult worships at the altar of GDP for ever chanting their mantra, "aggregate demand."

Agent P's picture

The Justin Bieber fanclub is NOT going to be happy with this play on words. Be afraid, very afraid.

ArmyofOne's picture

Come on Tuesday.


NipponMarketBlog's picture



$100 says this angle on the facts will get no mention in the popular media in Japan...

Anyway, I couldn't help notice the rhetorical question: "Can Japan sustainably lift aggregate demand above supply", implying over-supply.

There's no such thing as 'over-supply'. There is only prices that are too high, allowing zombie-companies to continue to survive. Untill and unless corporate Japan undergoes serious and wide-ranging restructuring, Japan will stay firmly on the road to nowhere (or worse).

wcvarones's picture

"Can Japan sustainably lift aggregate demand above supply?"

If not, it's obviously time to start smashing things to reduce supply.  Right, Keynesians?  Get out your sledgehammers!

katchum's picture

US numbers are phony, they artificially upgraded their GDP numbers. Which also means their debt to GDP is much higher.