In Part 1 of this piece we explored at a high level some of the impacts of Japanese monetary policy on on the real economy. We concluded that currency devaluation has been successful in raising import prices, but has so far been ineffectual in creating private demand or rising real wages. In this part we'll compare the composition of growth over the last year with the composition of growth over the last ten years, and then examine whether this composition of growth is 1) sustainable and 2) likely to continue in 2014.
Over the last ten years Japan has had three basic drivers of growth: private consumption (accounting for 65% of growth on average), public consumption (accounting for 22% of growth on average) and trade (accounting for 16% of growth on average).
Over the last year the composition of growth has changed dramatically and has been led primarily by: private consumption (accounting for 44% of growth on average), public investment (accounting for 31% of growth on average) and public consumption (accounting for 13% of growth on average). Government spending of one form or another has produced 43.3% of the growth over the last year vs the ten year average of 27.8%. This is clearly the result of the Abe-led expansionary fiscal policy, but we get the feeling this relatively large policy initiative is being confused for underlying demand.
The just released Indices of Building and Civil Engineering clearly paint the picture of weakening private investment and soaring public investment.
The question then is whether this type of government led growth is sustainable and the answer to that question is a resounding NO! At 9.2% of GDP, the country is running one of its largest budget deficits ever with a debt to GDP ratio of 209%.
Abe has a plan for this though. He has pushed through a consumption tax hike of 3% that will take effect in April of 2014. While fiscal retrenchment is obviously necessary, the tax increase combined with the tailwind from fiscal stimulus in 2013 turning into a headwind in 2014 will likely produce a drag on GDP of 2-4%, depending on how much fiscal tightening is actually allowed to occur. So unless the private sector ramps up investment and/or consumption or trade starts to pull some serious weight, there is a good chance Japan will wind up back in recession by the end of 2014. The problem with these rosy scenarios is that lack of capacity hasn't been a problem for years, consumption is likely to be brought forward ahead of the April tax hike (and thus be weak in the second half of 2014), and world trade has flat-lined with global growth estimates for 2014 coming down by the day.
With that said, count us skeptical in the Great Japanese Revival or the Abe Put. A more likely scenario seems to be the Great Japanese Fiscal Cliff that will unlikely be accompanied by a soaring Nikkei. Of course, that is a longer-term view that says little about the trading opportunities in Japanese assets, but we would caution against interpreting rising Japanese stocks to mean Abenomics has been a success.