- As goes Japan’s efforts to rescue it’s economy, so will go the U.S. and E.U.
- Japan’s options:
- Outsource its manufacturing base
- Replace as much human labor with automation as it can
- Rush to trade its depreciating currency for hard assets around the world
- What Japan is telling us about the Keynesian endpoint
Japan Is Reflecting the Future of Western Economies
While many observers continue to follow Europe as the proxy for post-growth dynamics in the OECD, it’s actually Japan that merits the closest analysis.
Much farther along in its post-growth phase, bloated with government debt and having tried a number of big-bang initiatives over the decades, Japan – not the U.S. or Europe – is leading the way. The country has never really recovered from the gigantic property and stock bubble over twenty years ago.
As proof, just consider the biggest trading story of the past 12 months. Was it the Federal Reserve’s intention to taper? How about the chaos in emerging market currencies in countries like India and Indonesia? Or perhaps the continued economic depression in peripheral Europe, as countries like Spain, Portugal, and Greece re-run the 1930s, with mass unemployment and people burning wood from forests to say warm? No, not even such dramatic suffering in Europe was enough to move markets or the EUR currency much this past year.
Instead, it was Abenomics and the front-running (and then chasing) of wildly huge moves in both the Nikkei and JPY that helped drive liquidity and speculative juices across all markets. It is not a coincidence that the peak of this frenzy in May heralded the peak in many markets.
But Japan has more than a financial problem. Despite the hand-wringing about Japan’s debt, the world has ignored for some time now Japan’s debt-to-GDP, GDP on an absolute basis, and Japan’s low cost of capital. Japan borrows. Japan prints. Japan devalues. But the world doesn’t care.
An issue the world may finally begin to care about, however, is that Japan has failed to launch itself out of deflation and is making very little progress in its struggle now. Indeed, Japan has a demographics problem and a resources problem that far outweigh its financial problems. To this point, instead of launching into recovery, Japan is running with the resources Red Queen, as every step of its currency devaluation is met with rising costs to import the raw materials Japan uses to make its goods. For comparison, Japan’s monthly exports are running around 5750 billion JPY. This is not impressive, either in relative or absolute terms, as the first chart showed in this report. With regards to exports, Japan has merely regained the higher level seen over the past few years.
But Japan’s import costs have soared. Yes, it’s not encouraging that Japan still runs a trade deficit, but it’s more concerning that Japan is running such a large energy deficit. (As a side note, the details of Japan’s import costs are not easy to come by; they are produced in an obscure PDF that is buried in the Ministry of Finance’s website. The international press deals mainly in the headline numbers, but the details are quite revealing.) Since Fukushima in 2011, and with the further pressures of currency devaluation, Japan’s cost to import energy has absolutely blown out – nearly doubling from 1,400 billion JPY per month to levels above 2,200 billion JPY per month:
Let’s pause here and consider the fearsome truth that Japan currently faces and the world may be coming to understand. Japan’s cost to import of energy is averaging around 35% of its earnings from all exports. And the situation can’t get better. Imagine: There is no prospect, none, that Japan can decrease the import of coal, oil, or LNG it needs to run its manufacturing base. Japan, Inc. runs on the spread between imported resources and exported goods. The above chart does not even include iron ore, copper, wood (yes, wood), foodstuffs, and other industrial metals and chemicals that Japan buys from the rest of the world each and every month.
Options for Japan
The OECD is plagued by either high resource costs, high labor costs, or both. Japan has a few options in this area and can follow the lead of both the U.S. and Europe:
- Japan can outsource its manufacturing to an OECD country like the U.S., which has very cheap electricity rates. Or to Africa, or other locales in Asia, where coal-fired power keeps electricity rates low. Like the U.S., which outsources its own high cost input – in this case of the U.S., labor – Japan may need to become much more aggressive in offshoring its manufacturing base.
- Japan, should it export more of its manufacturing to other domains, could then pursue robot and other automated manufacturing at home. Remember, Japan needs to concentrate, always, everywhere, and at all times, on the spread between energy inputs and manufactured outputs. Machine Intelligence will make an impact everywhere, in the U.S. and Europe as well. But the most efficient use of Japan’s high-cost electricity would be to take as much human labor out of its productive capacity and replace it with automated machinery.
- Japan could also start buying up property around the world, using its currency to aggressively acquire agriculture, dividend-paying equities, real estate, and infrastructure. By throwing away its depreciating currency, Japan could offset some of the losses in its human labor market by simply paying people to retire early. Again, you can already see vestiges of this in countries like the U.S., where structural unemployment has effectively closed the door on many workers ever returning to the workforce, as corporate earnings keep growing.
Japan’s predicament also helps to make clear that the United States and Europe, while also stuck in a post-growth era, are not likely to encounter such harsh limits any time soon. Europe stagnates but is a very efficient energy user. U.S. oil demand has essentially crashed, electricity rates are low, and we enjoy cheap natural gas, while at the same time we are building huge new capacity in wind and solar. All is not well in the U.S. or Europe, to be sure. However, no mechanism like Japan’s energy limit or Japan’s need to continually devalue hangs over the U.S. or European economies imminently. Analysts are going to have to adjust to this new reality in which stagnation and slow growth never lead to recovery, but never lead to any meaningful crisis either. (Indeed, as the frustrating set of circumstances carries onward, more people may actually start to wish for a crisis to flush the rot from the system).
Unless you believe that a volatile period in socio-cultural conditions is about to unfold in either the U.S. or Europe, Japan should now be your pole star to discern nearly all big oscillations and trends in global markets. Everything from commodity prices, to currencies, to equity prices will eventually have to answer to Japan. If you believe that global trade is going to pick up, and that emerging markets are going to return to a growth phase, then Japan will tell you first with a breakout of exports. If reflationary policy continues to make weak, plodding gains in both the U.S. and Europe, you can be sure that Japan will also be contemplating even more stimulus. Overall, it would be hard to envision global stock-market new highs, unless the Nikkei, too, sees new highs.
Japan’s race with the resource Red Queen is precious and valuable because it is the more acute, more perfect version of everything that plagues the rest of the developed world. While debt analysts like Kyle Bass wait for “the math” to play out in Japan’s credit markets, one is tempted to ask the following question: Why have international markets not already punished Japan, when its debt to GDP is already the highest in the developed world? (See accompanying chart from The Economist magazine showing Japan’s debt-to-GDP climbing steadily towards 250%.)
The answer is that Japan really has an energy problem, not a financial problem. In our post-growth world, the global economy remains trapped in the three senior currencies of the OECD: the USD, the EUR, and the JPY. Love them or hate them, the rest of the world does not command enough share of global trade to punish the OECD for its financial excesses. However, Japan’s impossible energy math will eventually be revealed to global financial markets, and unless a new set of radical measures of the kind cited here are undertaken, it will become clear that reflationary policy will have finally reached its terminus in Japan.
This is exciting! For years, most observers have wondered about the Keynesian endpoint. But ecological economics tells us that if enough resources – even marginal resources – are available, then Keynesian stimulus can “roughly work” for more years than one might have anticipated. Yes, the world increasingly runs on lousy, low quality, high-cost resources. Wealth, in traditional terms, is very much in decline. But this can go on for some decades.
What’s exciting about Japan is that an industrial island, a titan of the post-war era that arbitraged cheap energy, will be leader as unlimited reflationary policy finally, and I do mean finally, runs into the resource limit. That is why from here on in, it will be critical let Japan be your guiding light to the seemingly endless skirmish between the decline of the OECD, low growth, and central banking’s attempt to fight reality.