The Sugar High of Abenomics

By Brian Bremner

Japan’s Challenges: A World-Class Debt Problem ...


With five recessions since 1990 and a two-decade run of subpar growth, Japan hasn’t exactly been a model of economic dynamism. Nor is Shinzo Abe — the scion of one of Japan’s most prominent political families who started his second stint as prime minister in late December — anybody’s idea of a revolutionary. Yet since taking office, Abe has unleashed a barrage of deregulation initiatives, extreme monetary easing, a 2 percent inflation target, and $102 billion in stimulus. Abenomics, as the program is known, has sent the Nikkei up 25 percent this year. Japan’s economy grew 3.5 percent in the first quarter, outpacing that of the U.S. Abe even inspired a lingerie maker to create the Branomics Bra: Festooned with an upward arrow in red trim, it has extra padding for a 2 percent increase in volume.

Plenty of people are betting big on Abe’s success. Hedge fund traders such as Daniel Loeb, founder of Third Point, and billionaire investor Stanley Druckenmiller are staking money and professional reputations on the notion that Japan is a can’t-miss reflation trade. The way of Abe has become a rallying cry for Keynesians like Nobel laureate economists Paul Krugman and Joseph Stiglitz, who believe Abenomics may discredit pro-austerity advocates in the U.S. and Europe. China hawks in the Pentagon and on the U.S. National Security Council want a revived Japan with more resources to beef up its defense capabilities — something Abe indicated he’s game to do in his “Japan Is Back” speech at the Center for Strategic and International Studies during a late-February visit to Washington.

With Abemania spreading, a little perspective is in order. Whatever others believe Abenomics might mean, it really isn’t about restoring Japan to greatness; instead, it’s geared toward managing the country’s decline. Above all, Abe’s reforms must prepare Japan for what’s likely to be a bruising debt workout, a prolonged period of depopulation, and a steady erosion in economic performance well into the middle of this century. The government’s messaging on Abenomics tends to stress the reflationary dimensions of the plan rather than the big long-term challenges that will come later. Just as anywhere else in the world, in Japan talking too candidly about unpleasant economic truths can be political seppuku. “What they are doing right now is playing for time,” says Mikio Mizobata, an economic analyst with the Daiwa Institute of Research, describing Abe and his team. “The economy has improved, and consumer sentiment is looking up, so now is the time to get on with painful reforms.”

Abe says he decided to pursue Abenomics in part because the Japanese public was utterly demoralized from watching so many regional economies head to the sunny uplands of prosperity. “People who gaze at the future with bright aspirations vanish from Japan,” Abe said in Tokyo on May 23 at a conference on Asia’s future. “Young people stop getting married, and there is also little increase in the number of babies, who will shoulder the responsibilities of the future.”

That Abe, 58, is even in a position to address these problems is one of the most amazing stories in Japanese politics. He entered the Diet in 1993 representing a district in Yamaguchi prefecture, situated on the southwesternmost tip of Honshu, Japan’s largest island. The region, known for its winding coastlines, white sand beaches, and green pines, was one of the fiefdoms that masterminded the 1868 overthrow of the Tokugawa Shogunate, ending Japan’s more than 250-year seclusion. Yamaguchi has also produced more prime ministers than any other prefecture. In Abe’s extended family, both his grandfather, Nobusuke Kishi, and great-uncle Eisaku Sato have been premiers.

Kishi is the notable figure in Abe’s life. In the late 1930s he was a top administrator in Manchukuo, Japan’s puppet state in northern China. He served as minister of commerce and industry in Hideki Tojo’s government. Kishi then served time in the Sugamo prison after being arrested as a suspected war criminal — he was never charged, indicted, or tried — by U.S. Occupation authorities. By the 1950s he’d resurrected his career, helping to form the Liberal Democratic Party, which would dominate Japan’s political system for decades. After becoming premier in 1957, Kishi renegotiated the U.S.-Japan security treaty on more favorable terms for his country, a move that nonetheless set off mass demonstrations in Japan.

In his 2006 political manifesto, Towards a Beautiful Country, Abe writes admiringly of his grandfather as the inspiration for his conservative views. He also vowed to be a “fighting politician” committed to a diplomatic but assertive Japan. Before Abenomics, he was better known for his hawkish views on China and North Korea and for backing the revision of Article 9 of the Japanese constitution, the basis of Japan’s postwar pacifism. Abe has said it’s time for the country to return to being a nation-state that can, when appropriate, project military power to safeguard its interests. (Increased defense spending could also be a form of stimulus.)

Abe won his first premiership in September 2006 but resigned a year later, waylaid by scandals, a flap over lost pension records, and gastrointestinal problems that he said made governing impossible. From 2007 to late 2012, Japan blitzed through five prime ministers while coping with two epic calamities: first the global financial crisis and then the 2011 earthquake, tsunami, and nuclear-reactor meltdown in northeast Japan. With the economy sputtering, Abe and the LDP had an opening against Premier Yoshihiko Noda, head of the rival Democratic Party of Japan. In a way, Abe also ran against Bank of Japan Governor Masaaki Shirakawa, who had resisted calls for more radical monetary measures and warned of the inflationary dangers of excess liquidity.

Abe consulted with a group of Japanese economists known as the reflationists, who’d largely been ignored by the BOJ. They included retired Yale University professor Koichi Hamada (who taught Shirakawa economics) and Kaetsu University professor Yoichi Takahashi, a former Finance Ministry official who advocated a surge in Japan’s monetary base. In stump speeches, Abe talked of “unlimited easing” and developed a print-and-spend campaign platform. He also threatened, if elected, to revoke the BOJ’s charter guaranteeing its independence if the central bank didn’t comply. “For Japan, central bank independence has turned out very detrimental to our economy,” Hamada said in January. The tactic worked: Abe’s LDP-led coalition won a commanding majority in the Diet’s lower house.

In early April, the BOJ’s new governor, Haruhiko Kuroda, whom Abe had lured from the Asian Development Bank, announced shock-and-awe monetary targets for Japan. Kuroda aims to double the country’s monetary base by 2014 through increased purchases of Japanese government bonds. According to Masaaki Kanno, a former BOJ official and chief economist at JPMorgan Securities Japan, the planned 7.5 trillion yen ($75 billion) of monthly bond purchases would expand the bank’s balance sheet at a rate faster than that of the U.S. Federal Reserve, which has also adopted an ultra-loose monetary strategy. To achieve its goals, the BOJ is also intervening directly into the stock and real estate markets by buying equity-exchange-traded funds and real estate investment trusts. That’s something the U.S. Fed is prohibited from doing under the Federal Reserve Act, according to William Dudley, president of the Federal Reserve Bank of New York, who spoke on May 21 about Japanese monetary policy.

The BOJ moves and the fiscal package are the politically painless parts of Abenomics. The third part is a broad deregulatory effort that includes revamping the agricultural sector; promoting more innovation in the nation’s energy, pharmaceutical, and medical-device businesses; and opening up Japanese industries to more competition by having Japan join a U.S.-led regional trade pact called the Trans-Pacific Partnership. “The way Abenomics works is to lower interest rates, weaken the currency, and improve exports, leading to capital investment,” says Abe adviser Takahashi. “Deregulation will further help the effectiveness” of the government’s revival plan, he says.

Abe sent the Nikkei reeling on June 5 when he said his legislative push to reform the economy won’t happen until the fall. If he moves too slowly in addressing Japan’s fiscal mess or faces stiff resistance from less reform-driven LDP members, he also risks triggering a stock and bond market selloff that would cripple his efforts to revive confidence and business investment. Japan faces a Himalayan debt burden: It has the rich world’s highest ratio of gross public debt to economic output, projected by Japan’s Ministry of Finance to hit 224 percent of gross domestic product in 2013 — and that forecast came before Abe proposed 10.3 trillion yen in spending on public works and other measures in January.

Already, volatility has increased in the Japanese debt market, with yield on the benchmark 10-year Japanese Government Bond (JGB) approaching the 1 percent mark in May before dropping back. That’s low by international standards, but as rates creep up, so do the government’s considerable debt-servicing costs, which consume 24 percent of its budget, according to the Finance Ministry. The Nikkei experienced steep selloffs in May and early June; it’s off nearly 17 percent from recent highs. (Some investors view a decline of 10 percent or more as a correction.)

Hedge fund manager J. Kyle Bass, whose Hayman Advisors made $500 million during the U.S. subprime crisis, predicts a Japanese fiscal collapse. “Abe and the BOJ face what I call the ‘rational investor paradox,’ ” Bass told Bloomberg News. “If JGB investors begin to believe that Abenomics will be successful, they will ‘rationally’ sell JGBs to buy foreign bonds or equities.” That will place upward pressure on Japanese bond yields and government debt-service costs.

Abe has already indicated he wants to double Japan’s consumption tax to 10 percent and achieve a primary budget balance — in which government revenue equals outlays, excluding debt-service costs on existing liabilities — by 2020. The Daiwa Institute’s Mizobata says if the government is serious about hitting that goal, the consumption tax actually needs to hit 19 percent, given rapidly expanding outlays for social security and the state-run health-care system.

The best way to slay the debt beast is to grow, and getting there will require delivering on painful structural reforms that, inconveniently, hit business interests and rural regions that are a huge part of the LDP’s electoral base. That’s especially true of agriculture, a heavily government-subsidized sector riddled with poor distribution, a preponderance of older farmers, and inefficient land use. In a country where arable land is scarce, some 10 percent of current farmland is unused, according to Robert Feldman, a Tokyo-based economist for Morgan Stanley MUFG Securities.

Even if Abe somehow manages to clear these obstacles and the recovery maintains its momentum, Japan’s demographic challenges are impossible to ignore. The nation is simultaneously aging and shrinking at faster rates than previously thought — and they were already scary enough — according to a March 27 report by the Japanese National Institute of Population and Social Security Research. With its fertility rate stuck below the population-replacement level — 2.1 births per woman — since the early 1970s and a deep cultural resistance to immigration, Japan’s overall population is projected to fall about one-third from the 128 million counted in 2010 to 87 million by 2060. The crucial work-age cohort (15 to 64) will decline 46 percent to 44 million, while the 65-and-over crowd will grow from 23 percent of the population in 2010 to almost 40 percent.

Research by Sayuri Shirai, a BOJ policy board member and former Keio University economist, reveals that Japanese households whose heads are 65 and over represent 30 percent of all consumption in Japan. Drop that age to 60, and their spending share goes up to 40 percent. Japan’s biggest diaper maker, Unicharm, sells more nappies for adults than for babies. Stand-in relatives are available for rent when wedding parties need more kin. Food delivery services for seniors are expected to double in 10 years to 106 billion yen, while the market for food that doesn’t require much chewing will climb 61 percent to 158 billion yen, according to Fuji-Keizai Group, a marketing-research firm in Tokyo.

Japan’s share of the world economy is projected to fall by more than half, from 7 percent as of 2011 to 3 percent by 2060, according to the Organisation for Economic Co-operation and Development. The task for Abe and his team is to demonstrate that a diminished Japan can still remain influential, maintaining high living standards and a strong voice in international affairs. Transporting Japan back to the 1970s and 1980s, when Sony, Mitsubishi, and Fujitsu caused economic anxiety in the West, probably isn’t possible. Ultimately, Japan may be destined to become the Switzerland of Asia — a small but rich country punching above its weight class and boasting a quality of life the rest of the world envies. That’s a more modest goal for Abenomics than its many admirers might prefer. But it might be more attainable for Japan.

— With Isabel Reynolds in Tokyo


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