Impatient Shinzo Abe is playing hardball on wage inflation

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The Japanese government, specifically the Ministry of Economy, Trade and Industry, has taken the unprecedented step of threatening to disclose the names of companies that are not raising wages for workers.

This somewhat rough approach is unusual to say the least, and may seem like every socialist’s dream scenario. But one should not be fooled into thinking that Shinzo Abe’s heart necessarily bleeds for the average Japanese worker. This is simply part of the government’s ongoing attempt (for about a year now), to manufacture inflation in Japan – something that ultimately will NOT benefit the average consumer.

The government’s approach rests on the following assumptions: Higher wages will tend to induce consumers to spend more, which will – at least theoretically – allow companies to hike prices, increase earnings and thus afford salary increases, which will in turn lead to higher consumption and so on and so on, in a virtuous cycle that is meant to pull Japan out of the low growth, deflationary situation it has been mired in for a few decades now.

The publicised goal of this approach is to produce enough inflation to kick-start the Japanese economy and send it onto a self-sustained growth track. However, NipponMarketBlog has no doubt that the real and underlying goal is to create enough inflation to be able to ‘monetize’ the government’s enormous debt.

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As we have written about extensively (see this piece), the Japanese government finds itself being weighed down by a mountain of debt that threatens to bankrupt government finances. The debt is already at almost 250% of GDP, but the rapidly rising average age of the Japanese population, combined with the shrinking number of tax payers, means that public finances will become even more unbalanced in the years to come, even if the government starts cutting expenditure aggressively.

NipponMarketBlog is convinced that the Japanese government realises full well the impossible situation it is in, and has concluded that the only viable solution is to apply aggressive monetary policy to A) weaken the yen, thus providing a short term boost to large exporters’ profits and also creating cost-push inflation, and B) create enough inflation directly through an increase of the money supply, so that the debt stock (which is fixed in nominal terms) becomes relatively easier to manage as inflation levels (and thus also tax revenues) begin to rise. Theoretically, if the inflation level can outstrip the pace at which the nominal debt is increased then the government is actually balancing its budget in real cash flow terms.

However, the problem arises when interest rates begin to rise, and this is of course an inevitable consequence of rising inflation levels. As this happens, the government debt service costs will also begin to rise as more and more debt is rolled over at higher and higher interest rates. The sheer size of the debt means that even a small increase in interest rates will have a huge negative impact on the government’s cash flow.

So far though, the aggressive monetary policy engineered by the Bank of Japan has certainly had some effect, and prices in Japan are starting to rise, although still very slowly.

CPI - March 2014

CPI turned positive in June last year, and CPI ex. Food and Energy (two big ticket import items for Japan) turned positive only in September. Clearly, the rate of change in the inflation level is not sufficient for the government, or perhaps they are concerned that inflation might begin to taper off again, and this is presumably why they are attempting to force companies to raise wages by publicly shaming them.

What the government either fails to take into account, or perhaps simply chooses to ignore, is that the weakening Yen (which is a result of the BoJ’s aggressive monetary policy) is having a serious adverse effect on many Japanese companies through the much higher energy costs. Japan imports virtually all its energy, so any weakening of the Yen has a large impact on overall costs for corporate Japan. This is especially true for small companies. Japan’s self-sufficiency rate for energy is around 20%. If one excludes nuclear energy , which is becoming increasingly unpopular for obvious reasons, the self-sufficiency rate becomes as low as 5%. Please see this piece for more on the energy cost-push inflation effect.

However, Shinzo Abe has already had some apparent success in trying to force companies to raise wages, and with much fanfare it was announced in March that large companies such as Toyota and Panasonic will increase wages by 0.8% in the next financial year starting in April. The problem with this is that this is still less than the current inflation rate (now ticking over at around 1.5%), so it actually amounts to a reduction in real wages and thus consumers’ propensity to spend. And without consumer spending, the recovery will be short-lived, and Abenomics will fail. The government of course realises this – hence the push for publicly shaming companies that are not playing along with Abenomics.

On that note, it is worth keeping in mind that the Japanese sales tax will increase from 5% to 8% on April 1st. This is happening because the government desperately wants to begin to shore up its finances, but we at NipponMarketBlog fear that this is premature, simply because the recovery is not yet sufficiently entrenched. This risk here is that consumers will have front-loaded their expenditure over the past few months, and as soon as the higher consumption tax kicks in, consumption will slump. Please see this piece for more details of the impatient BoJ Governor Kuroda’s push for increased sales tax revenues.

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The wage inflation dynamic seems to NipponMarkeBlog to be one of the main problems with Abenomics. Wage inflation at any given time is almost always lagging current broad inflation levels (as measured by CPI), so the experience of the average consumer will almost always be that prices are rising faster than wages – at least in the beginning of a recovery – and this typically does not exactly induce the average consumer to spend more.

But because the Japanese government needs a large and rapid shift upwards in consumption, as opposed to a more gradual increase, the average consumer will invariably be faced with price rises outstripping their wage increases. This is especially true in a scenario where much of the rising inflation (especially that experienced by companies) is driven by higher energy costs and higher costs of other imported goods in general, which of course is a result of the BoJ’s monetary policy.

NipponMarketBlog believes it is important to understand that the currently higher inflation level is not a natural and healthy consequence of higher economic activity, but instead a sort of artificial accounting effect brought about by the BoJ simply increasing the number of Yen in circulation. It stands to reason that this will not benefit the average consumer – at least not for a substantial amount of time, until any recovery becomes self-sustained. For more on the inflation dynamics as they relate to the Abenomics experiment, please see this piece and this piece.

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It remains to be seen whether the Japanese economy can attain enough momentum to pull itself out of deflation on a sustained basis, and subsequently whether this will be enough to save Japanese government finances. NipponMarketBlog remains extremely sceptical, especially about the latter of the two. Even if it were theoretically possible to pull off this unprecedented experiment successfully, we feel that the political establishment in Japan lacks the internal cohesion and decisiveness that is required for such an experiment to  succeed. This of course does not mean that a fiscal collapse is imminent, and it is quite possible that Japan can keep muddling through for several more years. However, with the aggressive monetary policy now in place, there is effectively no way back (as we discussed in this piece).

The stakes have been raised substantially as a result of the implementation of Abenomics, and so if the economy starts to become fragile, and if government bond holders start to lose faith in Abenomics, things could turn very nasty, very quickly.

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One response to “Impatient Shinzo Abe is playing hardball on wage inflation”

  1. GG says :

    Hi. I came across this blog by accident while Google searching for JGB futures and ETF’s. So am just gonna ask here, in case you can help me with a query. Are there any Tokyo (or other exchanges) listed ETF’s that track the JGB 10 Year Futures? So far I have only found very illiquid USA listed ETN’s like JGBS and JGBD (non Optionable). I am looking for an ETF or tracker that has options to make a trade related to the JGB 10 yr bond. Not really interested in trading the futures. Any ideas?

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