A weakening yen inflates export data
The below graph reflects the ongoing growth in Japanese vehicle exports as well as growth in crude oil imports. As Japan imports over 40% of its energy needs, it feels significant economic pressure from purchasing oil. It should be remembered that the Japanese yen has weakened approximately 30% against the dollar and the euro since 2013. This weakening in the domestic currency has meant that Japan has had to spend much more on importing oil. As noted later in this series, this development has led to an immediate impact on Japan’s development of an ongoing trade deficit since 2012 as well. This article considers the inter-temporal cost/benefit of importing oil with a weakening currency versus exporting merchandise such as vehicles.
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The oil problem is a blessing for Japanese automakers
Japan’s drastically weakened currency since 2013 means different parts of the economy have felt different impacts. For Japan, more expensive oil is like a tax that is born by all consumers of imports—especially oil/power. However, for exporters, such as Japanese automakers, this development is typically a blessing, as the domestic costs’ base declines. As the above graph reflects, the yen-based level of Japanese auto exports has grown significantly since 2012. This reflects a weakening currency.
In the near term, the Japanese economy as a whole will feel the bite of more expensive oil—just as the U.S. did when it experienced the oil crisis of 1973. For the U.S., the rising price of oil in dollars led to significant domestic inflation. In 1973 and 1974, the cost of oil went from $3 per barrel to $12. With gas costing the U.S. consumer around 4% of their disposable personal income these days, we can see that a 400% increase in the price of gas is a significant impact. Japan will not be facing such levels of oil-related inflationary pressure, although it is facing some pressure, as reflected in the above graph.
Japan needs inflation
For Japan, the oil-related burden due to a weakening currency is a short-term negative in terms of its tax-like impact on the broader economy. However, as Japan has been trying to end deflation in the economy, the oil-driven trade deficit will provide additional inflationary support to the current aggressive monetary policy. The bank of Japan currently holds around $2. 2 trillion yen in assets, and may grow this level to $2.7 trillion by the end of next year. That level of asset purchases of the central bank of Japan equates to roughly 50% of Japan’s gross domestic product, in comparison to the U.S. Federal Reserve’s reflationary purchases, which rose to around 25% of the U.S. GDP.
Near-term negative, long-term positive
In the near term, Japan will experience economic pressure on more expensive oil imports. However, should the Japanese yen continue to weaken over time, eventually, this will mean more robust export growth and profits for Japanese exporters. The impact of currency-related crude prices are swift and immediate, while gearing up the manufacturing base for growth could take time and planning. Given that Japan has worked off much of its production capacity overhang since 2008, trade-related growth for Japan would likely involve more investment, and this would support economic growth and consumption in Japan in the future. The near term data could get ugly, although the long-run effects of a weaker currency should be positive, and Japanese automakers will likely be large beneficiaries of this long-term change in the weakening currency. Should things eventually evolve in this direction, the U.S. automakers could face greater price competition from Japanese exporters.
To see how Japan’s trade is developing with China, the U.S., and the European Union, read the next part of this series.
For an overview of the April 1, Bank of Japan Beige Book on Japan’s economic outlook, read Bank of Japan Tankan supports a 2014 equity rally in Japan.
For an overview of the U.S. macroeconomic recovery, which could support Japan’s export economy, read Market Realist US Macro Review, Q2 2014.
Japan’s equity outlook
As 2014 progresses, investors could see a continued outperformance of Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). Plus, as Japan pursues unprecedented monetary expansion, and the U.S. Fed tapers its bond purchases, Japanese equities could also outperform the broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV).