Last night, Japan’s GDP figures for Q3 came in much lower than expected. GDP fell an annualized 1.6% versus expectations for an annualized increase of 2.2%. This is as large a miss as you will see, and it calls into question the economic program administered by the Japanese government and the Bank of Japan. I have not been optimistic about Japan for some time. However, I think the numbers overstate the decline and have some further macro thoughts below.
Let’s go all the way back to December 2012 when Shinzo Abe became Prime Minister again and look at what was promised. On Christmas Eve 2012, I wrote a post titled, “Japan’s prime minister threatens to unify monetary and fiscal policy”. And the way I positioned what later became Abenomics is important. I wrote that “if the Bank of Japan loses its independence and the government gets to set monetary policy, we will effectively have one consolidated government balance sheet for fiscal and monetary policy. I think this will be the end stage for any nation looking to get out of the terminal debt stage.” So after years of trying to escape a debt deflationary trap, Abe finally realized that getting fiscal and monetary policy on the same page was important. What we could then see is a full-scale assault on the lack of demand in the private sector.
The key, here, however is the policy constraint. As I wrote then, “deficit hawks get sick of the large deficits and look for government to retrench by raising taxes and/or cutting expenses, something I see as inevitable. And the result every time is recession, further private deleveraging and large government deficits, despite the move toward austerity. This cycle has taken Japan to well over 200% government debt to GDP.” My point: short of war, you are never going to be able to use fiscal and monetary stimulus to get an economy on a self-sufficient demand growth path because the deficit created doing so will become politically radioactive. It is inevitable that government will retrench by raising taxes and/or cutting expenses. And we see that it is exactly the same here again. The consumption tax that the Japanese government raised in April has cratered demand and caused Japan to lapse back into recession.
If you look at the figures though demand was not the culprit for recession. Though private consumption rose only half as much as expected, it did rise 0.4% from the previous quarter, which is a decent number. It was business inventories that created the massive shortfall in GDP. So the consumption tax hit that has increased consumption tax to 8% from 5% first pulled forward demand into Q1, cratering demand in Q2, and causing businesses to purge inventories in Q3. That means it is unclear what the trend growth rate in Japan is at this moment, especially since business inventories can be a volatile element of GDP. Recent economic data suggest that new order flows to Japanese business are doing just fine. Perhaps, Q4 will be positive.
So I am not unduly alarmed by these figures. There is a lot of distortion to them from the one time increase in consumption taxes. And once this factor recedes, we will have a better gauge. That said, the consumption tax increase highlights the real problem with trying to get growth via the stimulus route. It is not a politically sustainable route to continued demand growth because the fiscal deficits it creates will always be undesirable to deficit hawks, who will work to remove them. The upshot then is that the fiscal tightening that follows in the wake of stimulus could have enough of an impact to create the self-feeding process that leads to a ‘real’ recession – lower net transfers to the private sector, lower disposable income, lower retail sales, inventory accumulation and a pullback in production – all of which we have seen – followed by a loss of jobs, a cut in wages, household sector debt distress and further losses to retail sales and consumption, which we have not yet seen. If we see job cuts increasing and unemployment rising in Japan, then the sales tax would have been a disaster. As it stands, it may just be temporary.
Nevertheless, I continue to view Abenomics as a failure because it has relied excessively on ephemeral increases to demand from fiscal and monetary stimulus without understanding that inflation has undercut corporate profitability and nominal wage gains. The goal of a higher inflation target in the absence of higher wages makes absolutely no sense and is destined to fail. Moreover, the negative outcome from increasing sales taxes so soon after stimulus began was foreseeable and negates all of the efforts made to date. I even predicted the failure in January and wrote about “the failure of Abenomics” on these exact grounds in March.
I don’t know where we go from here. Stocks may rally if the yen weakens. However, the negative impact on domestic purchasing power will take its toll. And if we continue to see weak wage growth, domestic demand will remain weak.