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Guest Post: Japan's Self-Defeating Mercantilism

Tyler Durden's picture


Authored by Joyce Poon, Gavekal Asia Research Director,

In the 16 months since Japanese Prime Minister Shinzo Abe launched his bold plan to reflate Japan’s shrinking economy the yen has depreciated by 22% against the dollar, 28% against the euro and 24% against the renminbi. The hope was to stimulate trade and push the current account decisively into the black. Yet the reverse has occurred. Japan’s external position has worsened due to anemic export growth and a spiraling energy import bill: in January it recorded a record monthly trade deficit of ¥2.8trn ($27.4bn). Having eked out a 0.7% current account surplus in 2013, Japan may this year swing into deficit for the first time since 1980. So why is the medicine not working?

The standard response revolves around timing issues: the so called J-curve effect usually means that the boost to exports after a currency devaluation lags the rise in the value of imports by about 12-18 months. In addition, consumers may be busily buying goods ahead of April’s scheduled sales tax increase, temporarily jacking up imports. On a more structural note, there is also the suspicion that exports are not benefitting from the cheaper yen partly because so much production has been pushed offshore.

This may all be true, but there is more to the story than the trade data. After all, a big devaluation has a ricochet effect across the broad economy that changes the outlook for producers, consumers, the government and providers of capital. The transmission mechanism can be thought as working in the following way. Consumers are immediately hit with an implicit “tax” as imported goods cost more, while export-oriented firms get an effective subsidy. In the capital markets, the effect is to lower the value of domestic bonds in foreign currency terms, with the result that yields rise. This means that the cost to the government of financing its deficit rises, forcing a reduction in government spending. As a result of these effects, resources are shifted from the household and government sectors and into the corporate sector. The effect of this resource reallocation should be to boost productivity, which in turn initiates a virtuous circle of rising incomes and ultimately higher consumption.

Unfortunately, Japan defies this textbook paradigm because in addition to devaluing, it is also engaging in massive quantitative easing. This keeps bond yields low, enabling the government to keep financing its deficit at low cost. There is thus no incentive for the government to cut spending— and in fact the consumption tax hike will be offset by even more spending. Furthermore, low bond yields suppress the financial income of household savers.

The end result of all this is that the government bears none of the burden of the adjustment and the household sector bears all of it, through higher import costs and lower financial income. With the household sector’s spending power thus crimped, companies have no incentive to invest in domestically-focused production. Instead, all their investment will be geared toward exports—mercantilism on steroids.

A mercantilist policy can feel like it is working during periods when strong global growth allows excess exports to be absorbed without ruinous price falls. Between 2001 and 2006 the yen devalued by almost 40% on a real effective exchange rate basis and Japan’s current account improved sharply. Japan may not have won back its global competitiveness (its share of the global export pie fell by 1.5 percentage points in the period), but strong external conditions did allow exports to grow 9% a year in dollar terms.

Today, Japanese exporters do not face such benign conditions and any successful mercantilist boost can only come from eating the lunch of rivals.

Since all the leading economies favor policies that support production over consumption, the world is getting more goods than it can absorb. The result is ongoing price declines, which have the effect of deferring the ultimate global recovery.

What this means is that Japan’s ultra-mercantilism is self defeating. In a global environment of weak demand and disinflation any volume increase in its exports will have to be paid for through price reductions. To be sure, in the short term the trade balance is likely to improve somewhat as a result of the J-curve effect taking hold. But in the longer term Japan looks to be entering a cycle where it must run harder just to stand still.

There are a few ways this could all end happily. Japan might embrace a structural reform agenda that boosts productivity, raises wages and pushes up domestic demand. Alternatively, world growth could surprise on the upside, creating a rerun of 2001-06. Energy prices could collapse, closing Japan’s trade deficit and reducing the incentives for mercantilist policy. But we are not holding our breath on any of these possibilities.

Instead, Japan’s most likely path is that the yen keeps falling, the BoJ keeps printing money, and the dollar value of exports stagnates as devaluation and price cuts offset any volume increases. And so, paradoxically, the current account will continue to deteriorate into permanent deficit, despite ultra-mercantilism. At this point the game will have changed in Japan and Abenomics will have manifestly failed to deliver on its stated objectives.

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Fri, 03/21/2014 - 21:09 | 4579201 johngaltfla
johngaltfla's picture
TSHTF Inflation


Nope. It is f'ing over. Get gold. Get Silver. Get ammo. The world is F'ED beyond belief.

Fri, 03/21/2014 - 21:36 | 4579261 Mister Kitty
Mister Kitty's picture

The Japanese need to get back into the business of military adventurism.  The world needs another Imperial Empire.  Bitches.

Fri, 03/21/2014 - 21:44 | 4579276 knukles
knukles's picture

Golly, when the rest of the world is stagnant growth, depreciating a currency will not increase exports.... It's the Liquidity Trap!
And when most of your energy is imported, then the real price of oil goes up as the currency goes down, inflation ...
Oh never mind...


Sun, 03/23/2014 - 12:12 | 4582411 mkkby
mkkby's picture

At least the people are smart enough not to bring kids into this increasingly festering swamp.  Fewer mouths to feed means the existing savings last a lot longer before having to move into a cardboard box.

Sat, 03/22/2014 - 04:30 | 4579777 asteroids
asteroids's picture

But wait, it gets far far worse. Japan is a rapidly aging society. The massive QE, new taxes, and debt burdon, will fall upon the young worker. This is why QE is evil, because it pushes the bill to your kids and grandkids. I see cat food for the old and revolution for the young. Oh yeah, the West will be in the same shape in about 5 yrs.

Sat, 03/22/2014 - 10:26 | 4580114 JamesBond
JamesBond's picture

I'll be back in Tokyo in two weeks.  Maybe I'll check out the new matchmaking parties; but I wonder what my Japanese wife would say...

Just trying to do my part honey!



Sat, 03/22/2014 - 09:26 | 4580009 thestarl
thestarl's picture

Everyone's just tapped out on debt where are all these magic consumers coming from,huh.

Games up, stagnating wages,energy costs through the fucking roof man and thats just for starters.

Sat, 03/22/2014 - 16:08 | 4580765 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

The magic money making sends most capital into the hands of the corps and wealthy. Average Joe gets squeezed out. If everyone is broke, how are corps to make money? Ohh wait, they won't.

Sun, 03/23/2014 - 12:03 | 4582393 mkkby
mkkby's picture

Corps will make money by cutting back, cutting back and moving to where labor is even cheaper than cheap. 

Average Joe...  wage cuts, part time, Obamacare tax increase, higher prices -- running harder to fall behind even faster.

Fri, 03/21/2014 - 21:09 | 4579203 Theta_Burn
Theta_Burn's picture

And they say America is fucked up........

Fri, 03/21/2014 - 23:27 | 4579530 NoDebt
NoDebt's picture

No, it's just behind the curve relative to Japan.

Fri, 03/21/2014 - 21:14 | 4579219 NoDecaf
NoDecaf's picture

Hope is not a plan.

Fri, 03/21/2014 - 21:44 | 4579277 prains
prains's picture

(H)ope is 10 letters too early

Fri, 03/21/2014 - 21:45 | 4579280 knukles
knukles's picture

That is beautiful

Fri, 03/21/2014 - 22:05 | 4579324 nmewn
nmewn's picture

But "change" can require one.

Sun, 03/23/2014 - 12:06 | 4582401 mkkby
mkkby's picture

When Kenyan O said "hope and change" he really meant "hope you find spare change."

Fri, 03/21/2014 - 21:18 | 4579232 ThroxxOfVron
ThroxxOfVron's picture

The Chinese continued building capacity and have been devaluing as well so as to completely overwhelm Japan's attempt at exporting deflation through devaluation.

I argued that Abenomics would only result in asset stripping of the Japanese middle class via a toxic combination of credit rationing, real negative interest rates, onerous direct taxation and indirect taxation in the form of inflated energy and foodstuff importation costs.

You cannot print your way out of energy or food dependency, nor make a continent out of an island, nor create real wealth with paper promises to do so.

Fri, 03/21/2014 - 21:39 | 4579248 Yen Cross
Yen Cross's picture

 I'm  MACRO short yen. I'll buy the dips.



Fri, 03/21/2014 - 21:50 | 4579298 Spungo
Spungo's picture

Destroying a currency to dramatically increase capital costs is BAD for the economy? I'm shocked. It worked so well in Zimbabwe and Weimar Germany. The German economy swiftly recovered, the economic prosperity of worthless paper money eased racial and religious tensions, and it led to world peace.

Fri, 03/21/2014 - 22:01 | 4579318 prains
prains's picture

Was that World Peace 1, 2 or 3, can't remember?

Fri, 03/21/2014 - 22:04 | 4579323 Yen Cross
Yen Cross's picture

 Prains don't sweat  it. You're on my "favorites" list!

Fri, 03/21/2014 - 22:16 | 4579336 prains
prains's picture

Piece is good for business, just don't want to become one is all

Fri, 03/21/2014 - 22:16 | 4579344 Yen Cross
Yen Cross's picture

 Peace? And I hear ya.

Fri, 03/21/2014 - 22:31 | 4579376 prains
prains's picture

.....keep low brother

Fri, 03/21/2014 - 22:04 | 4579322 AdvancingTime
AdvancingTime's picture

In Japan domestic investors have already started venturing overseas for higher yielding assets. If the value of the yen falls more than the stock values in Japan rise getting money out of Japan will be the only way to protect your wealth.

As this turns into a tsunami of money fleeing Japan and becomes a feed back loop that fuels itself it will constitute the end of the line for those holding both JGBs and the yen. Details in the article below,


Fri, 03/21/2014 - 22:06 | 4579328 Yen Cross
Yen Cross's picture

  Let's discuss offshore BoJ flows?  The shit that can never be paid for? ALA 1985?

Sat, 03/22/2014 - 12:05 | 4580326 Seeking Aphids
Seeking Aphids's picture

Exactly A....I expect that gold/silver must also be on the radar of Japanese investors as a way to preserve value without having to 'expatriate' their wealth.....anyone know where we can get recent stats on Japanese gold/silver purchases?

Fri, 03/21/2014 - 23:19 | 4579508 Central Ohio
Central Ohio's picture

"Unfortunately, Japan defies this textbook paradigm..."  We could substitute, the US for Japan.  

Fri, 03/21/2014 - 23:31 | 4579539 NoDebt
NoDebt's picture

You're right, but early.

Fri, 03/21/2014 - 23:23 | 4579519 LMAOLORI
LMAOLORI's picture



Does anyone know where a chart is showing how much of our debt Japan holds? It's really the broke funding the broke.



Fri, 03/21/2014 - 23:26 | 4579528 laomei
laomei's picture

Energy costs increasing, and after relying on China for so long for their "Made In Japan (but not really)" manufacturing as well as exports... and screwing that pooch by allowing their nutjobs to piss of enough people to mount effective boycotts.... they are just plain screwed in so many ways it's not even funny.  A cheap yen implodes their economy due to the carry trades and ZIRP/NIRP policies, and an expensive yen decimates what's left of their economy.  They be fucked.

Sat, 03/22/2014 - 11:21 | 4580241 matrix2012
matrix2012's picture

"A cheap yen implodes their economy due to the carry trades and ZIRP/NIRP policies..."


a carry trade (and zero/negative rate) due to cheap yen implodes economy ???

may anyone pls help to explain above causality by carry trade in plain English... :-)

Sat, 03/22/2014 - 00:04 | 4579604 q99x2
q99x2's picture

mount effective boycotts


exile the globalists.

Sat, 03/22/2014 - 10:39 | 4580138 Yancey Ward
Yancey Ward's picture

Taken to its logical conclusion, devaluing your currency so you can increase exports and economic activity within your borders means that you do best to give stuff away to foreigners.

Sat, 03/22/2014 - 10:47 | 4580160 bugs_
bugs_'s picture

good article Joyce

We see China's self-defeating (neo)Mercantilism following in the footsteps of the EU's self-defeating (neo)Mercantilism following in the footsteps of Japan's self-defeating (neo)Mercantilism.  The only curiosity for debate is the question of "Do they know they destroyed their own market or was that their intent?"

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