Japan needs to get its game on if it is compete with China, but Tokyo's newish Ministry of Economic Security is not the tool for the job. Image: Facebook

TOKYO – On October 18, the top article on the front page of Japan’s leading business daily screamed that cutting off imports from China would cost Japan 53 trillion yen (US$353 billion) in lost production, or about 10% of annual gross domestic product (GDP).

Meanwhile, the yen has depreciated by 31% against the US dollar since March, radically changing the dynamics of Japan’s international trade and investment and its domestic economy.

As calculated by Professor Yasuyuki Todo of Waseda University, using Japan’s Fugaku supercomputer, “Zero China” would wreak havoc on the nation’s economy. Without parts and materials imported from China, production of consumer electronics, autos, clothing and other items could come to a halt in just two months.

Switching suppliers would be expensive, resulting for example in a 50% increase in the price of a personal computer and a 20% increase in the price of a smartphone in the estimation of Owls, a consulting firm based in Tokyo.

But those estimates don’t consider the bigger economic picture.

The “California Jupiter” container ship owned by the Japanese shipping company Nippon Yusen K K unloads cargo at the Port of Los Angeles. Way more of Japan’s trade goes to China these days. Photo: AFP / Mike Nelson

According to Japanese government data, exports to China amounted to $206.2 billion in 2021, while imports from China amounted to $165.9 billion. What would happen to that trade if Japan were to cut off imports from China as part of a campaign orchestrated by the US? How would China respond? How much of that trade would be at risk?

In 2021, Japanese exports to the US amounted to $135.1 billion while imports from the US amounted to $75 billion. Japan’s total trade with China (exports + imports), therefore, was 77% greater than its total trade with the US.

The US ran a $355 billion trade deficit with China in 2021 and an even larger deficit of almost $370 billion in the first eight months of this year, with the monthly deficit reaching $50 billion in August.

The US talks a blue streak about resilient supply chains and decoupling from authoritarian regimes – but its own dependence on China, as measured by trade in goods, is rising, not falling.

US policy now is focused on cutting off high-tech exports to China, which puts Japan between a rock and a hard place. Japanese makers of industrial robots, electric vehicle components, semiconductor production equipment and other precision-manufactured products do a lot of business in China.

The IPEF, the Indo-Pacific Economic Framework for Prosperity proposed and led by the US, aims to reduce the economic risk of potential conflict between China and Taiwan. A Nikkei newspaper survey of 100 company presidents found 96 of them worried about the possibility of an emergency and 82 have either drawn up or are currently considering contingency plans to continue their business.

In this context, it is interesting to note a recent comment by US President Joe Biden. On October 6, speaking about the CHIPS and Science Act at IBM in Poughkeepsie, New York, he said: “More Americans have learned the phrase ‘supply chain’ and what it means. Well, guess what? The supply chain is going to start here and end here — in the United States. I’m not joking.”

Biden in Poughkeepsie. Photo: Daily Freeman

What are the Japanese supposed to think about that? And the South Koreans and Taiwanese, who also trade a lot more with China than they do with the US?

At 150 to the US dollar, the yen has depreciated by 31% since early March to its lowest level in 32 years. When Shinzo Abe became prime minister in September 2012, the rate was 78. In a decade, the value of the yen as measured in dollars has fallen almost by half.

The yen’s depreciation against other currencies has not been as spectacular, but it has been significant: down 17.5% against the euro, down 14% against the Chinese yuan and down 12% against the South Korean won since March this year.

Yen depreciation brings both benefits and problems. It is a net positive for Japanese manufacturing, as Nicholas Smith, equity market strategist at CLSA Japan, explained in a post on LinkedIn at the beginning of August:

Japan is now a brutally competitive production base. Its real effective exchange rate shows the trade-weighted currency, adjusted for its relative lack of inflation. It therefore shows the country’s cost-competitiveness. Since its 1995 peak, it has fallen 58%, and by 17.5% from the average for 2021. But over the same period, China’s real effective exchange rate has soared, with the result that since 1995, Japan’s has fallen 75% relative to China’s. Since its 1998 peak against South Korea’s, it has fallen 64% – and 15% against its 2021 average.

As defined by the World Bank, the “real effective exchange rate” (as opposed to the rates reported every day) “is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs.”

The weak yen supports the revitalization of regional economies in Japan through the construction of new semiconductor, electronic component and machinery factories. Japanese exporters have gained a huge advantage, particularly against US counterparts, who are being priced out of world markets due to the hyper-strong dollar.

The yen value of Japan’s overseas investments has also gone up, while foreign direct investment (FDI) in Japan is now much more affordable. Semiconductor makers TSMC and Micron – and Google, which plans to build a data center in Japan – should benefit.

The weak yen will also benefit the tourist industry as Covid restrictions are lifted and inbound travel recovers. Japan is now a very cheap tourist destination. The high cost of imported energy and raw materials also encourages conservation, but here we have both cause and effect as the trade deficit balloons, causing the yen to fall farther.

The weak yen is also driving inflation to politically unsustainable levels. Japan’s official core consumer price index (CPI) rose to an eight-year high of 3% in September – but inflation, as experienced by ordinary people at the supermarket, in cafes and restaurants, and paying utility bills, is in the double-digits. Shrink-flation (smaller packages or fewer tomatoes in the same-sized package with no change in price) is now rampant in Japan.

For this reason, and because more price increases are expected by the end of the year, the Japanese Trade Union Confederation is reportedly aiming for a 5% increase in next spring’s negotiations, which would be the highest target in 28 years. Business leaders say that would be difficult – and it probably would be if or when a recession causes profits to fall.

In September, when the yen-dollar exchange rate hit 145, the Japanese government intervened in the currency market for the first time in more than 20 years. The yen strengthened for a few days, but then resumed its downward course.

With the rate now at 150, Masato Kanda, vice finance minister for international affairs, has told the media that the government is ready to take action against excessive volatility.

The yen is in freefall. Photo: Wikimedia Commons

He specified volatility, not exchange rates per se – although the statement may simply have been a warning to short sellers.

As recently as October 15, Bank of Japan Governor Haruhiko Kuroda reiterated his position that it is necessary and appropriate to continue supporting the economy with low-interest rates. Kuroda was speaking at the International Banking Seminar of the Group of Thirty in Washington, DC.

The Group of Thirty is, in its own words, “an independent global body comprised of economic and financial leaders from the public and private sectors and academia. It aims to deepen understanding of global economic and financial issues, and to explore the international repercussions of decisions taken in the public and private sectors.”

The International Banking Seminar is “an invitation-only forum that allows for discussion and debate of the most pressing issues confronting the central banking community. Each year the Seminar brings together over fifty percent of the world’s central bank governors, the chairmen and CEOs of the financial sector, and a select few academics to debate financial and systemic issues of global importance.”

The monetary policy and economic trajectory of Japan is certainly of global importance. As interest rates go up in the US, Europe and elsewhere, Japan remains a holdout as one of the last bastions of near-zero interest rates.

Kuroda’s term as Bank of Japan governor ends next April. Will he defend his policy until then, or reverse course, declare victory over inflation and stop the depreciation of the yen with a modest interest rate hike? If he doesn’t raise rates, his successor probably will.

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