Modest tightening moves taken by Bank of Japan Governor Haruhiko Kuroda have been enough to affect US bonds. Photo: AFP/Jiji Press

Donald Trump’s trade war just claimed its biggest victim – and it is not China. It is Japan, a nation run by the only world leader the US president might call a friend.

In recent days, Singapore, South Korea and Taiwan all saw significant U-turns in their terms of trade at the end of 2018. News today that Japan’s exports fell 3.8% in December from a year ago demonstrates the extent of collateral damage from the trans-Pacific tariff war. It also shifts the political calculus for Prime Minister Shinzo Abe’s 2019.

Xi Jinping’s China is more directly in harm’s way than Abe’s Japan. But as the most powerful leader Beijing has seen in generations, Xi has myriad levers at his disposal to gin up growth and no elections about which to worry. Xi also can herd the People’s Bank of China and municipal leaders into aggressive action to safeguard growth.

Conversely, Abe’s headaches have only just begun. Here are four realities that Wednesday’s export data alter.

One: Recession watch is on

At the start of this week, Tokyo was still engaged in the collective denial that the 2.5% contraction in third-quarter growth was an aberration. Hopes for a fourth-quarter snapback are now impossible to sustain, never mind the weak external sector that confronts Japan this year. Recession risks are rising by the day.

External events also bode ill for Abenomics reforms this year. The headwinds began in 2018, of course. Last year was supposed to be the one when Japan Inc. finally opened its wallet and raised wages. That was until Trump’s levies on steel (25%), aluminum (10%) and $250 billion of Chinese goods (25%). The cash executives did share with workers tended to be one-time bonuses, not the formal salary increases required to influence consumption in the long run.

If Abe’s team punted on politically-challenging steps to loosen labor markets, cut red tape and raise productivity amid 3% growth, it’s safe to assume any planned 2019 upgrades are off the table. The same could be true in Korea, amid signs that Asia’s No. 4 economy in 2018 might have grown at its slowest pace since 2012. Korea also saw a 3.9% fall in exports in 2018’s fourth quarter.

Two: The BOJ outlook

Twelve months ago, Bank of Japan Governor Haruhiko Kuroda was plotting an exit from history’s most aggressive quantitative easing experiment. His team was telegraphing “tapering” moves and steps to throttle back on annual asset purchases of $730 billion. Yet 2018 ended with the BOJ only halfway to its 2% inflation target.

The year ahead will see even fewer inflation pressures. What’s more, Kuroda’s team is sure to be in the hot seat to print even more yen. The immediate goal is capping the yen’s advance, which is further imperiling the export outlook. Its 4.4% rally since October augurs poorly for exports, and in turn gross domestic product, in early 2019.

There’s more Kuroda can do. Since the BOJ owns more than half of the government bond market and 75% of exchange-traded funds, policymakers are likely to aim elsewhere. They could pump cash into corporate debt and markets for asset-backed and mortgage-backed securities. They could gorge on local government debt. Or find ways to inject cash directly into households.

Will it work? It’s doubtful without Abe doing his part to deregulate the economy. Even so, the BOJ’s printing presses are back in business.

Three: The tax debate

You’d think Abe’s Liberal Democratic Party might’ve learned something in 2014: raising taxes in a deflationary environment ends in recession. Yes, that happened – when the LDP hiked the sales tax to 8% from 5%. In October, Team Abe plans to bump it to 10%. What could go wrong?

The irony, of course, is that Tokyo is raising taxes to pay down the developed world’s biggest public debt burden. Yet, the LDP had to cobble together a stimulus package paid for with, wait for it, fresh government borrowing to offset the effects. Tokyo’s debt load is more than twice the size of its $4.9 trillion economy, and still growing.

The specter of another tax increase could further depress household consumption and business confidence. As such, expect Abe’s government to spend more time these next few months debating taxes than implementing structural upgrades.

Four: Dealing with Trump

Abe spent much of 2018 finding ways to put off bilateral trade talks with Washington. Luckily for Tokyo, trade negotiations with China, summits with North Korea’s Kim Jong Un and myriad investigations in Washington got in the way. No such luck this year. With legislative prospects dwindling at home, Trump is desperate for a quick win overseas.

That puts pal Abe in an impossible position. Abe’s choice is between risking Trump’s Twitter wrath or angering the LDP’s conservative base. The zero-sum US leader, after all, doesn’t do trade negotiations. He does shakedowns.

Seoul could suffer fallout, too, if Abe plays hard to get. Trump might make good on threats to slap 25% taxes on imports of cars and auto parts. That would slam Hyundai, Kia and any company integrally linked to global supply chains.

Trump has also threatened non-intervention clauses for currencies of US trading partners. That’s code for a weaker dollar.

It’s a wildcard neither Japan’s Abe of Korea’s Moon Jae-in needs as their respective economies slow.

Welcome to Northeast Asia’s year of risk.

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