China's de­val­u­a­tion be­comes Ja­pan's prob­lem

The Pak Banker - - OPINION - Wil­liam Pe­sek

Among the clear­est ca­su­al­ties of China's de­val­u­a­tion is the Bank of Ja­pan. The chances were never high that Gover­nor Haruhiko Kuroda was go­ing to be able to un­wind his in­sti­tu­tion's ag­gres­sive mon­e­tary experiment any­time soon. But the odds are now lower than even skep­tics would have pre­vi­ously be­lieved.

The real ques­tion, though, is what China's move means more broadly for Abe­nomics. A sharply de­val­ued yen, af­ter all, is the core of Prime Min­is­ter Shinzo Abe's gam­bit to end Ja­pan's 25-year funk. Abe­nomics is said to have three parts, but mon­e­tary eas­ing has re­ally been the only one. Fis­cal-ex­pan­sion was neutered by last year's sales-tax hike, while struc­tural re­form has ar­rived only in a brief flurry, not the avalanche needed to en­liven ag­ing Ja­pan and get com­pa­nies to raise wages.

China's de­val­u­a­tion tosses two im­me­di­ate prob­lems Ja­pan's way. The first is re­duced ex­ports. As Bei­jing guides its cur­rency even lower, as surely it will, the yen will rise on a trade-weighted ba­sis. And Bloomberg's Ja­pan economist Yuki Ma­su­jima points out that trade with China now con­trib­utes 13 per­cent more to Ja­panese GDP than the U.S., tra­di­tion­ally Tokyo's main cus­tomer. "Given China's rise to promi­nence, the yen-yuan ex­change rate now has far greater in­flu­ence on Ja­pan than the yen­dol­lar rate," Ma­su­jima says.

The other prob­lem is psy­cho­log­i­cal. Ja­panese house­holds have long lamented their ris­ing re­liance on China, a de­vel­op­ing na­tion run by a gov­ern­ment they widely view as hos­tile. But the BOJ was glad to evoke China's 7 per­cent growth -- and the mil­lions of Chi­nese tourists fill­ing shop­ping malls across the Ja­panese ar­chi­pel­ago -- to con­vince Ja­panese con­sumers and ex­ec­u­tives that their own econ­omy was in good shape. Now, the per­cep­tion of China as a growth en­gine is fiz­zling, ex­ac­er­bat­ing the ex­change-rate ef­fect.

"To the ex­tent that the de­pre­ci­a­tion re­flects weak­ness in China, then that weak­ness -rather than the de­pre­ci­a­tion per se -- is a prob­lem for Ja­pan," says Richard Katz, who pub­lishes the New York-based Ori­en­tal Economist Re­port. It's also a prob­lem for Abe, whose ap­proval rat­ings are now in the low 30s thanks to his un­pop­u­lar ef­forts to "rein­ter­pret" the paci­fist con­sti­tu­tion to de­ploy troops over­seas. The prospect that Abe will en­rage Ja­pan's neigh­bors by wa­ter­ing down past World War II apolo­gies at cer­e­monies this week­end mark­ing the 70th an­niver­sary of the end of the war is fur­ther damp­ing sup­port at home.

The wors­en­ing econ­omy, which vot­ers hoped Abe would have sorted out by now, doesn't help. In­fla­tion-ad­justed wages dropped 2.9 per­cent in June, a sign Mon­day's sec­ond-quar­ter gross do­mes­tic prod­uct re­port for the may be truly ugly. It's an open ques­tion whether such an un­pop­u­lar leader can push painful, but nec­es­sary, struc­tural changes through par­lia­ment. "Al­ready," Katz says, "Abe has backpedaled on many is­sues to avoid fur­ther drops." Af­ter 961 days, all Abe­nomics has re­ally achieved is a sharply weaker yen, mod­est steps to tighten cor­po­rate gov­er­nance and mar­ket­ing slo­gans ask­ing com­pa­nies to hire more women.

There could be a sil­ver lin­ing here: China's move may cat­alyze Abe to act. By un­der­cut­ting Ja­pan's de­val­u­a­tion, China might in­crease Abe's ur­gency to boost com­petive­ness, in­no­va­tion and wages. Al­ready, Abe's sur­ro­gates are set­ting the stage for more BOJ eas­ing. One top ad­vi­sor, Koichi Ha­mada, told Bloomberg News that "the mag­ni­tude of China's shock is much larger than that from Greece." China's de­val­u­a­tion, he added, "can be off­set" by fresh BOJ ac­tion.

But Abe would be wise to re­act with far more than just another yen de­val­u­a­tion. If Ja­pan of­fers a cau­tion­ary tale, it's that weaker cur­rency alone isn't the an­swer. If Abe had used the yen's 35 per­cent plunge since late 2012 to good ef­fect -- pass­ing big re­forms on la­bor flex­i­bil­ity, im­port tar­iffs, tax pol­icy, sup­port­ing star­tups, re­duc­ing red tape -- Ja­pan might not be fac­ing the prospect of another re­ces­sion. Un­less the prime min­is­ter changes course, Abe­nomics will be re­mem­bered as a pol­icy that pri­mar­ily ben­e­fited stock-trad­ing hedge funds, not av­er­age house­holds.

Yesterday, in a rare press brief­ing, China's cen­tral bank down­played fears of huge moves that desta­bi­lize mar­kets. Yet as growth sput­ters, Bei­jing will weaken the yuan as much as it can get away with geopo­lit­i­cally.

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