Japanese trade balance worsens, despite weak Yen.
Japan’s trade deficit widened in December, with imports coming in at 7.4 trn Yen and exports coming in at 6.1 trn Yen, for a net deficit of 1.3 trn Yen. This takes the total for 2013 to 11.5 trn Yen, which is the highest since comparable data started in 1979. The following chart illustrates monthly import and export data (bn Yen) for the past 2 years:
The net figures for the trade balance for the same period are as follows:
On the face of it these figures, and in particular the trend in the monthly data, look quite negative. However, one has to be slightly cautious when interpreting trade data, and a lot of pundits and even seasoned investors tend to think of trade data as a simple score sheet where ‘higher’ is always ‘better’. However, things are a little bit more complicated than that. It stands to reason that international trade is a zero-sum-game, so not all countries can produce a trade surplus and certainly not all the time. For one country to be running a surplus, another country must be running a corresponding deficit. Therefore, trade surpluses and deficits must and do change over time as each country moves through different stages of its individual growth cycle.
Ordinarily, a ‘worsening’ trade balance of course means that the country is importing more than it is exporting, and so will often be interpreted as a negative for the economy. But trade deficits are often an indication of higher internal/domestic economic growth, which naturally requires both more input materials for industry and more goods for consumption. The former is especially relevant for Japan, which has virtually no natural resources and so must import everything it needs for manufacturing and energy use. The latter is increasingly becoming a factor, as Japanese consumers gradually loosen their purse strings in tandem with the perception that the country’s economy is improving.
In order to arrive at a better understanding of Japan’s trade figures, we therefore also need to look at indicators of economic activity. Firstly, let’s have a look at monthly Industrial Production data since 2008:
Clearly, industrial production overall remains relatively firm, but then anything else would be a disappointment given the concerted efforts by the government and the BoJ to stimulate the economy (please see our piece here for details). Below, we have picked out a few sub-sector time series which we think are interesting:
The machinery sector activity is a bell-weather indicator for overall activity in Japan, and indeed the YoY change in machinery orders enters into most leading economic indicators. Industrial production in the machinery sub-sector is more or less in line with overall economic activity, and the same goes for Electrical machinery (Major electronics manufacturers) and Transport equipment (auto sector). Interestingly the Semiconductor manufacturing equipment sub-sector (which includes LCD, TFT, OLED machinery) has seen a significant pickup recently, after lagging behind for the past year or so.
Finally we present the industrial production index for the Construction machinery sub-sector, which includes exports of construction machinery to countries such as China:
This last sub-sector has been a spectacular success story for many years now, and we suspect that increasing domestic demand from the revitalised housing and construction sector could also be playing a part here.
Overall though, it is clear from the charts above that overall economic activity remains relatively robust, and so this would lend credence to the assertion that the significant trade deficits observed in recent months is at least partly a function of relatively high levels of activity in the Japanese economy overall.
However, another extremely important factor that must be discussed in connection with trade data is the currency. In Japan’s case, the currency has always been a major factor when it comes to determining the country’s growth, and even more so its corporate profits. In fact, Japanese equity markets are probably more sensitive to currency swings than any other major equity market in the world.
Corporate Japan has no doubt benefitted enormously from the significantly weaker yen over the past few years, but as we have discussed here, the other side of this particular coin is significantly higher fuel costs which eats into corporate profits and depresses overall economic growth. The net outcome for the economy is difficult to determine, especially over the medium to long term.
There is no doubt that the weaker Yen has been a boon for the equity market, since it almost immediately translates into higher corporate profits, but NipponMarketBlog remains concerned that the wider impact on the economy is anything but universally positive. In particular, we find it very worrying indeed that Japan’s trade balance remains so stubbornly in the red, despite the fact that the Yen has weakened by around 25-30% over the past two years, exemplified by the USDJPY which has gone from around 75 to above 100 over the 2012-13 period:
One would have thought that for such an export-dependant economy, such a significant weakening would have brought with it a positive trade balance, but this illustrates just how important energy costs are as a swing factor in relation to Japan’s trade balance.
When one considers that fuel imports constitute around 35% of total import value, and that these costs have gone up by around 25% in the past year or so (or roughly the decrease in the value of he Yen versus the USD), it becomes clear that a very large proportion of the deteriorating trade balance is caused by higher energy costs, as a direct result of the weaker Yen.
On the point about higher energy costs (brought about by the weaker Yen, which is turn is a phenomenon intentionally engineered by the BoJ), NipponMarketBlog can’t help thinking of this as a hidden tax on both the Japanese consumer and on corporate Japan. It may well be that a weaker Yen, combined with monetary and fiscal stimulus, will force through higher levels of inflation which in turn will increase nominal tax revenues (and thereby reduce the relative debt service burden for the government), but it is in effect just another wealth transfer from consumers and businesses to the government.
The Nikkei 225 took a slight tumble on the announcement of these figures (down 2.5% on the day), but this type of knee jerk reaction is not necessarily a predictor of the future. Much of corporate Japan – mainly large export focussed manufacturing companies – are currently enjoying record profits, and this section has historically been quite adept at moving production abroad to low cost countries, thereby also ensuring that the energy costs related to running these facilities are not settled in Yen. However, for the non-exporting part of the Japanese economy the operating environment has become quite a bit more challenging of late, despite the nascent recovery in consumption.
Tinkering with the exchange rate is not on its own going to propel the Japanese economy along on a self-sustained recovery track. It may provide an initial boost, providing the increased corporate profits translate into higher domestic wages, which unfortunately does not seem likely at the moment (see this piece).
Ultimately however, as we have discussed several times in the past (here and here), Japan is in need of serious and deep structural reform if it is going to be successful in achieving the goal of reinvigorating itself and perhaps also shifting the emphasis slightly from being an export-driven economy to a more self-sustained domestic demand driven economy. This is important not only because Japan’s domestic economy is relatively isolated from competition and therefore quite inefficient in places, but mainly because the future demographics of the country simply dictate lower tax revenues, and an increasing financing burden on the shrinking working population, which in turn makes productivity improvements an imperative. Part of the Abenomics program is to address structural reforms in the Japanese domestic demand related economy, but so far precious little has materialised.
Of course, the ultimate goal of Abenomics is to avert the government defaulting on its debt, but NipponMarketBlog remains sceptical about the long term success of this plan (see this piece), especially because we question the degree to which the government and the BoJ will be able to maintain control of interest rates as inflation continues to climb, and as the marginal buyer of JGBs in the years ahead increasingly becomes foreign. In addition, we fear that the much needed structural reforms risk running aground on the rocky shore that is domestic Japanese politics and vested interests. This is something that has happened several times before, including during times of much more conducive global growth prospects, and under the leadership of much more popular and charismatic Prime Ministers than is currently the case.
Importantly however, this does not stop Japanese equities from being an excellent place to invest, and as demonstrated by recent equity market trends, investors can find plenty of attractive companies to buy. As long as one is mindful of the macro-economic caveats that exist, and as long as one is prepared to put in the effort do serious company research and carry out careful valuation analysis and stock picking, there are always plenty of interesting new investment opportunities opening up (something NipponMarketBlog has discussed in detail here).