Go easy on the umeshu tonight! But buy it, it’s likely holding value a lot better than the yen. Here’s my thoughts on what it will likely look like when we all wake up on Monday morning, given that Shinzo Abe has won the election by a strong-enough majority to exclude “third force” parties.
Political promises kept?
I doubt very much that the campaigning platform he has ran on will be possible without strong backing from the shadow rulers of Japan’s political sphere and the blessings of its kingmakers. In particular, I do believe that any constitutional reform of the self-defense forces and central bank charter will be nearly impossible to enact – no matter who is in the hot seat. Yes, Abe Shinzo likely gets enough of a majority that he gets the ability to push sweeping change, the question is if he has even a tenth of noda’s guts to push them. Hope his bowel problems on the way out last time wasn’t a premonition…
Will the Trans-Pacific Partnership be signed? Given a state of policy of inaction, I very much doubt so. Especially given the Japanese farming lobby push to avoid it, and Mr. Abe’s strong links to them. He is way too entrenched in the way things are to put a sledgehammer to it. Similarly, the trade frictions with China do not really look like they will fall a lot.
Then there is the beautiful problem of the wasteful spending policies of the LDP. I believe much more strongly in the DPJ’s policies of investing in the knowledge economy rather than building better train services and airports in a public works spending plan, which has been a stalwart of LDP policy. (Most of the airports are effectively unused and servicing them made JAL go into bankruptcy. Your train services are the best in the world, so no need there.) What about wifi hotspots and broadband connections if you absolutely have to invest in infrastructure? A central tenet of the campaigning policy of Mr. Abe has been the idea of increased public spending, but at the same time he advocates spending cuts and efficiency gains. I doubt very much he can achieve both.
With regards to the Bank of Japan, I doubt that they will be easing particularly much more as it stands – they have done quite well on that front already. Masaaki Shirakawa will likely stand his ground, but the question lingers in his succession, whom Abe will have the right to appoint. After that there is a pretty questionable image of what is needed to cause strong inflation. Assuming that growth is somewhat lagging and unlikely to soar in the current status quo where there is a conflict with China, and neither Europe nor the US looks likely to see a strong growth spurt, we keep growth constant at 0.5%. Then, the Bank of Japan would essentially need to print M2 * ([desired inflation rate] – [positive change in velocity of money] – 0.5%). M2 thus becomes extremely important. How do we forecast that?
The moving parts in the M2 equation is the velocity of money, and the underlying pace of economic activity in Japan. Regarding effect of the tax rate increase that was clubbed through, a major contributor to this is naturally the pace of new housing purchases which is expected to kick in soon given that the agreements need to be signed roughly one year before any transaction takes place, and that the first marginal tax rate increase will be on April 1st, 2014. If we say that this increases to roughly 110000 units monthly in a year from now, it would indicate a “return to trend” following the Global financial crisis as seen in the chart below. This is probably the most important leading indicator of the tax hike effect.
Putting numbers to this, using the greater Tokyo area as a benchmark estimated at roughly 20% above the rest of the nation, and seeing the numbers from Tokyo allows us to do some rough guesstimations.
We give the new-to-old ratio a value of roughly 3 from data found elsewhere on Japan Property Central, that courtesy of REINS for use later. Discount this to 5/6 for the country overall. Assuming a new construction sells for roughly 27 million yen on average in Japan, this corresponds to 670 billion yen, or $7.9 billion. New housing speculated increases therefore corresponds to about 4.5% of GDP in Japan, and transactions for these take up 1% of money supply! Housing transactions overall would contribute totally 14.3% of GDP by these calculations, and the increase represents a money supply percentage of 3.4%. There are of course several substitution items that are not bought instead, so we estimate the total velocity-of-M2 effect of this to be around half of these values initially.
We also expect a “natural” rate of M2 velocity decline of 2% in line with average 20-year and recent history, although I see a gradual move afterwards to a greater change of M2 as housing transactions increase and the next tax hike rolls around. More likely than not, the substitution effects will (if there is any growth at all and inflation takes some hold) be replaced by a par effect and then a multiplier effect. Factoring in the estimated effects of reduced savings and increased consumption due to old age is not done here due to the difficulty in estimating the correct time of such an event.
So, essentially, I estimate that there will be a 1.7 – 2.0 = 0.3% decline in inflation due to velocity of money effects in Japanese fiscal 2013. this would thus for a 2% inflation target require 2% + 0.3% – 0.5% = 1.8% of M2 to be printed in addition to current policy by the Bank of Japan. We then see, given that Japan has a 820 trillion yen M2 supply, that we need 14.8 trillion yen in increased money supply, which could be relaxed later using this forecast.
Wider Investing World Effects
To be certain, Mr. Abe’s talk has done more to perk up the stock market and lower the price of the yen than anything that the DPJ administration or Masaaki Shirakawa at the BOJ has done as of late. Expecting this to continue, we could of course speculate that there will be a strong increase in the sales of Japanese goods in the longer run (if they actually try to paper things over with China) due to the relative pricing of their goods getting much more competitive. the stock market should thus continue to see roughly 2 times beta to the inverse yen performance.
Estimating currencies and these effects tot the accuracy and model comprehension I would want to is obviously very difficult. I strongly believe that the trend of the currency however will make the yen a popular carry funding harbour yet again, and the internationalization of Japanese investments are likely to be maintained as they want to reduce risks. Our differential equation would thus be set for a yen fall. One wonders when “Mrs. Watanabe” will join in and speculate harder in other currencies, if they can find any good ones to buy into.
What will this look like 5 years down the line?
Of course this is filled with so many ifs and buts and maybes that it’s almost impossible to forecast, but what I see is that this is “it” for the system either way. One direction is deterioration of the current macroeconomic picture into perpetuity (Abe maintains power for a longer period of time and economic/political conditions allow him to both kill the tax hikes and avoid any opening up of trade treaties) and there will be increasing misery in Japan. Industry slowly gets hollowed out and the last people who even remember the Japanese Miracle will leave the earth with their era just becoming a legacy for the history books, like the Samurai.
Alternatively, he sticks hard with his campaign promises, growth goes well enough for a year or two to maintain the tax hike, things then spiral out of control 2-3 years down the line, and we can see JGB yields spiking through the ceiling right as deposit redemptions start pouring in and capital starts flying out. The ensuing economic conflagration is large enough that the political system gets upended and everyone starts from scratch with the government in default and deposits flying back in to generate huge economic returns.
Tomorrow marks the beginning of the end of the Japan we once knew, if that is a positive thing, or if the system is so change-resistant that even crashing it by overextending the same policies from within won’t work, only time will tell, I guess.