Amid chatter about the “Japanification” of China’s economy, it’s wise to keep an eye on how Beijing’s troubles might scuttle Tokyo’s recovery, too.
There’s little doubt that Asia’s biggest economy has students of Japan’s lost decades worried. Look no further than stagnant Chinese growth, weak consumer prices and troubles in the property sector that echo Japan’s 1990s bad loan crisis.
Yet as China’s 2024 prospects wane, its biggest trading partners are coming to terms with the collateral damage to come. Japan is uniquely vulnerable to China’s downshift amid myriad global headwinds and other dynamics—including controversies over patents.
“Looking further down the horizon, Japan’s economy will be hurt by a lasting deceleration in Chinese growth, the techno-war and geopolitical tension between China and the West that has led to de-risking and Chinese intellectual property theft from Japanese firms located inside China,” says economist Richard Katz, publisher of the Japan Economy Watch newsletter.
The biggest immediate impact, Katz says, is exports. He calculates that every 10% decline in exports to China directly reduces Japan’s gross domestic product by 0.4%. That’s roughly the amount by which Japan’s exports to China fell in the first eight months of 2023. Things, of course, may get worse as U.S. bond yields and global tensions surge in tandem.
In addition, Katz notes, every 1% drop in Chinese GDP growth shaves off about 0.3% of GDP for Asia generally. These dynamics explain why the Bank of Japan is in no hurry to take its foot off the monetary accelerator pedal.
Since April, global markets have been betting (wrongly) that new BOJ Governor Kazuo Ueda would begin exiting from 23 years of quantitative easing. Ueda had been treading carefully, hoping the data would suggest Japanese wages are perking up. No such luck.
Now, as chaos in the Middle East shakes world markets, the BOJ is even less likely to tap the brakes. That’s despite Japanese inflation hitting 30-yeat highs this year, in part because of a weak yen. The yen’s 14% drop this year has Japan importing higher costs thanks to elevated food and energy prices.
Until last weekend, the rise in oil prices was driven by post-Covid-19 supply/demand mismatches and Russia’s Ukraine invasion. Now, the shock attack by Hamas inside Israel has corporate executives, investors and households alike bracing for new waves of commodity-driven inflation.
If BOJ head Ueda regrets taking Prime Minister Fumio Kishida’s call earlier this year, the feeling is wholly understandable. After two-plus decades of zero-to-negative borrowing costs, the BOJ is naturally anxious to pivot toward some semblance of normality.
Ueda’s predecessor demurred when given the change late last year to begin, or even to telegraph, a policy shift. It was Governor Haruhiko Kuroda, after all, who took the BOJ deeper down the QE rabbit hole. Beginning in 2013, Kuroda expanded the BOJ’s balance sheet in ways no central bank ever had. By 2018, Kuroda’s policy of hoarding bonds and stocks supersized the BOJ’s balance sheet to the point where it exceeded Japan’s $5 trillion GDP.
Trouble is, that was pretty much all Tokyo did to rekindle Japan’s animal spirits. In a sense, Kuroda was left hanging by the ruling Liberal Democratic Party. In 2013, the LDP pledged to reduce bureaucracy, modernize labor markets, increase productivity, incentivize innovation and empower women. Mostly, it relied on hyper-aggressive BOJ easing to restore growth.
Sure, the LDP made progress on corporate governance. Starting in 2014, it prodded companies to improve returns on equity, diversify boardrooms and listen to shareholders. But a dearth of reforms elsewhere means that Warren Buffett and his ilk are benefiting more than 126 million Japanese realizing that trickle-down economics still doesn’t work.
In December, Kuroda did indeed test markets’ tolerance for change. But his move to let 10-year yields rise as high as 0.5% backfired spectacularly. As the yen skyrocketed and global markets quaked, the BOJ scrambled to increase bond purchases to contain the resulting turmoil in markets.
It now falls to Ueda to find a way forward as Japan grapples with inflation and deflationary forces simultaneously, not to mention recession worries for 2024.
“This is a tough time to be a central banker everywhere in the developed world, but the job of monetary policymakers is possibly harder in Japan than anywhere else,” says Gavekal Dragonomics economist Udith Sikand.
The problem, Sikand says, “is that with the BOJ retaining its ultra-easy stance while central banks elsewhere are tightening, the resulting depreciation of the yen has led to so much inflation of the wrong sort—imported inflation—that real wage growth is negative, suppressing consumer demand and making the BOJ’s policy goal ever less attainable.”
Add in the increasing blowback from China’s slowdown and it’s doubtful any economist would relish sitting in Ueda’s chair right now. The irony is that the more China risks a Japan-like funk, the more its stumble risks taking Japan’s economy down a peg, too.
