Among the clearest casualties of China's devaluation is the Bank of Japan. The chances were never high that Governor Haruhiko Kuroda was going to be able to unwind his institution's aggressive monetary experiment anytime soon. But the odds are now lower than even skeptics would have previously believed.
The real question, though, is what China's move means more broadly for Abenomics. A sharply devalued yen, after all, is the core of Prime Minister Shinzo Abe's gambit to end Japan's 25-year funk. Abenomics is said to have three parts, but monetary easing has really been the only one. Fiscal-expansion was neutered by last year's sales-tax hike, while structural reform has arrived only in a brief flurry, not the avalanche needed to enliven aging Japan and get companies to raise wages.
China's devaluation tosses two immediate problems Japan's way. The first is reduced exports. As Beijing guides its currency even lower, as surely it will, the yen will rise on a trade-weighted basis. And Bloomberg's Japan economist Yuki Masujima points out that trade with China now contributes 13 percent more to Japanese GDP than the U.S., traditionally Tokyo's main customer.
"Given China's rise to prominence, the yen-yuan exchange rate now has far greater influence on Japan than the yen-dollar rate," Masujima says.
The other problem is psychological. Japanese households have long lamented their rising reliance on China, a developing nation run by a government they widely view as hostile. But the BOJ was glad to evoke China's 7 percent growth -- and the millions of Chinese tourists filling shopping malls across the Japanese archipelago -- to convince Japanese consumers and executives that their own economy was in good shape. Now, the perception of China as a growth engine is fizzling, exacerbating the exchange-rate effect.
"To the extent that the depreciation reflects weakness in China, then that weakness -- rather than the depreciation per se -- is a problem for Japan," says Richard Katz, who publishes the New York-based Oriental Economist Report.
It's also a problem for Abe, whose approval ratings are now in the low 30s thanks to his unpopular efforts to "reinterpret" the pacifist constitution to deploy troops overseas. The prospect that Abe will enrage Japan's neighbors by watering down past World War II apologies at ceremonies this weekend marking the 70th anniversary of the end of the war is further damping support at home.
The worsening economy, which voters hoped Abe would have sorted out by now, doesn't help. Inflation-adjusted wages dropped 2.9 percent in June, a sign Monday's second-quarter gross domestic product report for the may be truly ugly.
It's an open question whether such an unpopular leader can push painful, but necessary, structural changes through parliament. "Already," Katz says, "Abe has backpedaled on many issues to avoid further drops." After 961 days, all Abenomics has really achieved is a sharply weaker yen, modest steps to tighten corporate governance and marketing slogans asking companies to hire more women.
There could be a silver lining here: China's move may catalyze Abe to act. By undercutting Japan's devaluation, China might increase Abe's urgency to boost competiveness, innovation and wages.
Already, Abe's surrogates are setting the stage for more BOJ easing. One top advisor, Koichi Hamada, told Bloomberg News that "the magnitude of China’s shock is much larger than that from Greece." China's devaluation, he added, "can be offset" by fresh BOJ action.
But Abe would be wise to react with far more than just another yen devaluation. If Japan offers a cautionary tale, it's that weaker currency alone isn't the answer. If Abe had used the yen's 35 percent plunge since late 2012 to good effect -- passing big reforms on labor flexibility, import tariffs, tax policy, supporting startups, reducing red tape -- Japan might not be facing the prospect of another recession. Unless the prime minister changes course, Abenomics will be remembered as a policy that primarily benefited stock-trading hedge funds, not average households.
Yesterday, in a rare press briefing, China's central bank downplayed fears of huge moves that destabilize markets. Yet as growth sputters, Beijing will weaken the yuan as much as it can get away with geopolitically. Depending on how Tokyo reacts, this could be the moment Abenomics gains traction or becomes a $4.6 trillion casualty of China's ascendancy.
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