Shinzo Abe’s speech to the Davos pantomime was a wake-up call. The Japan Prime Minister, now G-20 chairman until the end of June, signaled with his speech that he has now become a Europhile, and is moving away from a U.S.-centered approach. Washington, global markets, and Japanese savers should all take careful note. The likely consequences are not pretty.
Much of this stems from Abe’s interest in continuing to expand trade relations with China. Everyone and their dog know that Germany and Japan are the two lead advanced economies which have integrated themselves with China, using that country for example as a final assembly location for their exports and in the process shifting a large part of their own potential bilateral trade surplus with the U.S. to the People’s Republic.
Earlier in the month, Prime Minister Abe on his lightning-European tour dropped in on Theresa May to publicly warn the British Prime Minister against defying EU power with a no-deal Brexit. And he let the Brexiters know, if they had any illusions about this matter, Tokyo would not reward their defiance by opening talks on a free trade deal between the two island economies.
Meanwhile, back in Tokyo, Prime Minister Abe’s Bank of Japan Chief, Haruhiko Kuroda, announced that there is to be no turning back from monetary radicalism featuring euro-style negative interest rates and long-term interest rate manipulation. Certainly, these policies have not pushed the inflation rate up to the 2 percent target. But who doesn’t know by now that the real purpose of monetary radicalism under present circumstances is currency manipulation and stealth taxation of fellow citizens?
There is nothing new about Japan periodically embracing European alliances and learning from Europe. The tradition goes all the way back to the Meiji restoration. And the danger that European ties can stoke frictions in U.S.-Japan relations is also familiar. But now Japan’s geo-political situation is particularly fragile. The U.S.—not the EU—is Japan’s more reliable partner in security.
Yet the essence of a Europhile policy for Tokyo is close friendship with the EU hegemon, Berlin. We know that the Trump administration is watchful and alert to how Germany has been “gaming” global trade and security to the disadvantage of the U.S. The rapprochement of Tokyo and Berlin implicit in the concluding of the EU-Japan trade deal jars with the length of time during which the Abe government, worried about new demands to curb official or unofficial protection of its farmers and auto-makers, stalled the opening of talks with Washington on a free trade agreement (FTA) (eventually agreeing to their start last fall).
Also jarring was the alacrity with which Tokyo concluded a Trans-Pacific Partnership (TPP) deal once the Trump administration turned its back on this, meaning that Japan has become the hegemon of a regional free trade area including Canada and Australia (but ostensibly so far excluding South Korea and India). Indeed, in some respects Canada’s own FTA with the EU, coming into effect last year, was a model for the Japan-EU deal.
One objective of Tokyo in its FTA with the EU was an expansion of the market for Japanese autos. Matching concessions to European agriculture are in areas which don’t compete with its own highly protected farmers (cheese, wine, pork, beef). Increasing financial integration also made sense not least given the massive accumulated stock of financial assets held in the eurozone by Japanese investors made desperate for yield by the radical monetary experimentation of “Abenomics.”
Doubling Down on Abenomics
The yield-hungry Japanese have flocked to French government bonds (attracted by their yield spread over German and yet the perception of France at the EU core). There has also been a huge build-up of much higher yielding and riskier Italian government bonds. No wonder Shinzo Abe is shoulder to shoulder with Angela Merkel in hostility and fear of any “populist” quake under the EU – whether a no deal Brexit or anything else—which could cause the pillars of the eurozone for fall.
Prime Minister Abe and his architects of economic policy would not admit to having spread the terror of income famine amongst their fellow citizens. After all, he told the Davos “crowd” that Abenomics had “defeated defeatism” and thereby the Japanese economy is prospering. The business statistics are at least superficially on his side for now.
The cheap yen for Japan, like the cheap euro for Germany, has stimulated a cumulative rapid growth of the export sector. But German and Japanese households (other than those earning bonuses in the big exporter corporations) are quietly suffering. Some may delude themselves that speculative froth will continue to compensate for negative returns on domestic bonds and money; but most realize that to attain their objective of accumulating capital for retirement, they have to save even harder than otherwise.
The burden on the Japanese saver is even greater than the German, in fact. The zero yield on 10-year JGBs compares to 10-year Bund yields at 0.2%. But JGBs are substantially riskier than Bunds as reflected in credit ratings. Moreover, investors in Bunds reap a potential prize if one day the Deutsche mark is reborn. Yes, present reported inflation in Germany is higher than in Japan. But further ahead, looking at the weak state of public finances in Japan and the likely time-limited nature of present downward forces on prices there (especially integration with Southeast Asia and especially China) that relative situation could easily go into reverse.
In German democracy, increasingly pluralistic, there are political forces which could strengthen and bring a halt to radical monetary inflation policies as pursued by the ECB. In Japan, by contrast, one party dominance makes any such challenge implausible. And in any case, there is not the same “distributional resentment” to fuel discontent.
In Japan all households are subject to tax by stealth on their savings. In Europe, the tax is concentrated in Germany and other Northern European EMU members. The Italians, in particular, though are not subject to this in that their banks and government are gradually being recapitalized to their benefit by the transfer. German resentment in particular of the transfer is what might eventually fan sufficient support on the right (and possibly far left) to topple the centrist governments presided over by Chancellor Merkel or her successor.
If eventually the Merkel regime and the EU status quo over which it presides crashes, then historians will say that Prime Minister Abe made a big error in betting so much on a new alliance with Europe.