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By HaleStewart January 2, 2015 12:06 pm
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Potential 2015 Flashpoint #3: Japan

     Shinzo Abe was elected to the position of Japanese Prime Minister in 2012, largely on his plan to reinvigorate the Japanese economy after nearly two decades of stagnation.  His plan had “three arrows:” a massive currency devaluation, fiscal stimulus and structural reform in several areas such as getting more women into the labor force and making it easier for companies to restructure their operations.  The currency devaluation was easy, primarily because it could be accomplished by the Bank of Japan acting unilaterally.  The currency devaluation had two purposes: to increase exports and inflation.  However, after the devaluation occurred, it was learned that most Japanese companies had moved their operations offshore, meaning a lower yen wasn’t nearly as beneficial as implied.  And while inflation has increased, the pace of the increases have stalled of late.

     Although there has been some fiscal stimulus as well, it hasn’t been as large as desired.  And the structural reforms are proving to be somewhat elusive.  But despite having limited implementation of these two “arrows,” the overall growth rate of Japan picked up in early 2013, printing three consecutive quarters of growth.  

     But not only does Japan have a near two decade long problem of economic stagnation, they also face the problem of having a very high public debt.  In an effort to increase revenue to pay down this debt, Japan increased the sales tax in the spring.  This created an enormous problem: it pulled consumption forward in the first quarter of 2014:

    Since the implementation of the sales tax increase, overall growth has stalled as shown in this table from the Bank of Japan:

In the second and third quarter, growth decreased at a 6.7% and 1.7% annualized pace, respectively.  And the breadth of the slowdown has been wide.  Private demand decreased in both quarters.  And various parts of private demand contracted, with private demands, residential and non-residential investment contracting in the 2Q and residential, non-residential and inventory investment contracting in the third.  Public demand barely increased in both quarters, registering a paltry .1%.  And exports are clearly not benefitting to the degree intended from the yen’s devaluation.  

     So, what can we expect from the next few quarters?  Nothing great:

Both the leading and coincident indicators are at weak levels. 

     The biggest concern for Japan going forward is that there is a structural problem that can’t be fixed – that they are simply stuck in a period of incredibly weak growth caused by an aging population and stagnating corporate culture.  If this is the case, then we’re in for more weak news.  However, there is still hope that Abe’s plan will help to spark growth at a faster pace.  Considering he recently won a snap election, this is always a possibility.   

      Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer

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