Japan’s Most Recent Trillion Dollar Gambit
A fortnight ago, we explored the reasons why the fortunes of equity markets and the underlying economies where they are listed often appear disconnected. The severe exogenous shock of COVID -19 and the stimulus measures enacted by policymakers to mitigate its worst effects mean disparate economic and market performances predominate across much of the global economy.
Nowhere is this phenomenon more evident than the world’s third-largest economy; Japan. As one the world’s most open economies, boasting some of the world’s largest multinational companies, Japan’s economy and equity markets have mirrored the fortunes of other economically developed nations over the last few months.
Likewise, the Japanese government and Bank of Japan have pursued some of the most aggressive policy actions aimed at stemming the economic carnage released by COVID-19’s spread. This week the Japanese government approved the latest gargantuan stimulus bill, and we explore the details below.
First, we assess the prevailing economic and market backdrop of Japan.
The Japanese economy vs Japanese equity market
Since their nadir of March 23rd, global equity markets have responded positively to the extraordinary policies implemented by the US Federal Reserve and other central banks. The asset purchasing programmes, committing central banks to purchase corporate bonds, allowed liquidity to flow through the financial system, helping generate increased investor appetites for riskier investments, including equities.
Indeed, one of Japan’s leading equity indices rebounded by nearly 30% off its recent lows, as displayed in Graph 1. However, as we all now generally appreciate the broader economic picture which lies in front of us is less clear.
Graph 1: Nikkei 225 Recovery
Source: Bloomberg, data as of the 26/05/2020
Graph 2 depicts the quarterly economic growth of the Japanese economy from Q4 2017 until Q1 2020. From the chart, it is evident that the Japanese economy lacked vitality even before COVID-19’s spread. For example, in the fourth quarter of 2019, the economy contracted by 1.9%. On an annualised basis corresponds to a fall of over 7%. The cause of the economic contraction? Increases in consumption taxation stifled consumer demand.
This negative trend continued into the first quarter of 2020, with the economy falling more by 0.9% as COVID related effects started to bite in earnest by early March. Taken together, this means Japan’s economy entered a technical recession earlier than most other developed economies.
Graph 2: Japanese Quarterly Economic Growth
Source: Bloomberg, data as of the 31/03/2020
The earlier consumption tax-induced weakness of the economy, coupled with the additional shock caused by COVID-19, has elevated the need for aggressive action. Below we examine the measures approved.
Details of the package
On Wednesday the Japanese government approved an additional, and whopping, 117 trillion Japanese Yen in additional spending, equivalent to US $1.1 trillion. The announcement represents the second instance in recent months of the Japanese government compelled to announce extraordinary measures to bolster the economy.
The total value of Japanese fiscal stimulus deployed in the last three months amounts to over 230 trillion yen. In dollar terms, equivalent in value to $2.2 trillion, rivalling the scale of the stimulus package enacted by the US. To put this into context, it represents an eye-watering 40% of the value of Japan’s Gross Domestic Product, almost four times the relative scale of the measures enacted by the US government.
The package includes provision for rent subsidies for households, and small and medium-sized business most adversely impacted by Covid-19 pandemic. Other measures include a $29 billion commitment for vaccine research, as well as direct cash payments to frontline medical professionals.
Additional context – Japan’s economic history
During the late 1980s, the Japanese economy exhibited a period of rapid and sustained economic growth. In fact, forecasts suggested Japan would supplant the United States as the world’s largest economy. Fast forward a quarter of a century and the halcyon days of the 1980s are a hazy memory.
A debilitating asset price bubble collapse in 1991 led to a period of economic stagnation that lasted for the rest of the 1990s and much of the following decade, with the effect being the Japanese economy is now only ¼ of the size of the US economy.
Whether the latest bout of economic shock therapy can reignite the Japanese economy on a long-term, upward trajectory to past glories is unlikely. For all the technical prowess and innovation of Japanese firms, the economy faces a significant demographic challenge in the form of a shrinking population. However, the main emphasis now is to prevent stagnation and to ensure the return of some inflation.
It is essential to recognise the objective of Japan’s stimulus is to enable companies and individuals to avoid insolvency and navigate the turbulence caused by COVID-19. At 40% of GDP, the scale of the fiscal stimulus deployed is unparalleled anywhere and shows real determination to underpin recovery and to avoid price deflation.
Throughout the developed world the pandemic has been characterised by significant, innovative policy responses and the resolve to fight the COVID war remains in-tact. Even the European Union, perennially accused of failing to act in the face of repeated economic hardships, appears to be prepared to use whatever means necessary to aid member states and regions worst affected by the pandemic.
The determination we have witnessed is impressive, and with the spread of Covid-19 appearing to abate finally, the stimulus packages cement the foundations for the next chapter of demand recovery and increasing economic growth.