How Can We Tell If 'Abenomics' Is Working?
Japan is in the midst of a grand experiment to revivify its economy through a three-pronged campaign of monetary easing, fiscal stimulus and structural reforms. The markets have noticed: The Nikkei stock index has gained more than 70 percent while the yen has become more than 22 percent cheaper relative to the dollar and the euro since mid-November. At the same time, the difference in yields between 5-year Japanese government bonds and their inflation-indexed equivalents has widened by more than a percentage point.
All of this has led some observers to declare that Japanese expectations about inflation and growth have been transformed, thereby leading to a resurgence of domestic spending, hiring and investment. It's unclear, however, that this has actually happened.
Let's start with the obvious: Wages, prices, retail sales and industrial production are all flat or falling. On the bright side, the earnings outlook for Japanese firms is much better than it was six months ago, both in absolute terms and relative to firms in other rich countries. Those forecasts, however, are predicated on the belief that the Japanese economy will live up to the hype.
The recent action in the financial markets is actually less revealing than one might think. According to Goldman Sachs's economic research team, the surge in breakeven inflation can be explained almost entirely by a planned increase in consumption taxes that will hit in 2014. (Japanese inflation-linked bonds are also notoriously illiquid, which makes them unreliable indicators for much of anything.) According to data from the Tokyo Stock Exchange, the Japanese have been selling shares to foreigners for months. Any price increase is due to foreign demand rather than changes in the portfolio allocations of Japanese savers.
That's all the more remarkable considering that Japanese households are among the most conservative savers in the world. The biggest single asset on the typical household balance sheet is cash. We can't say that consumer expectations have changed until that cash starts moving into domestic stocks and real assets. So far, we have no evidence of that.
The behavior of Japanese savers also makes me wonder what is going on with the yen. Some analysts argue that the exchange rate is merely adjusting to a new set of inflation expectations, rather than reflecting a conscious strategy to boost export earnings and protect Japanese firms from their Korean competitors. This makes some sense. In the years before the crisis, nominal interest rates were much higher in Europe and the U.S. than in Japan, although inflation-adjusted rates weren't that much different because Japan had deflation while Europe and the U.S. had inflation.
While nominal interest rates have converged around zero across the rich world since the crisis, the inflation differential has persisted. As a result, real interest rates have been higher in Japan than elsewhere, which helps explain why the yen soared in value against most other currencies from the middle of 2008 until last fall. It therefore stands to reason that the yen should become cheaper in nominal terms -- as long as the Bank of Japan succeeds at eliminating the inflation differential.
There is much more to exchange rate movements than inflation differentials, however. Japanese households and firms own more than $6.7 trillion worth of non-Japanese assets, of which more than 37 percent is invested in bonds. If Japanese savers were genuinely convinced that their nation's prospects had improved, I would expect them to move their money out of these foreign assets and into domestic assets.
Similarly, I would think that U.S. and European investors convinced of the power of "Abenomics" would want to get in on the action by buying Japanese assets. Many of those investors won't hedge their currency exposure. All of this ought to cause the yen to appreciate, not decline.
Taken together, there isn't yet evidence that Abenomics has had much of an impact outside of American academia and a few macro hedge funds. Let's hope that changes soon.
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