With hindsight, Japan managed its economy relatively well in 2017. What should we look for Japan in the new year?
Broadly speaking, economists, analysts and the media are optimistic about the Japanese economy the next year. But let me point out seven things to watch for Japan next year, some of them potential dangers.
1. The North Korean crisis
The wildest card of all is, needless to say, the North Korean Crisis. Some say a military confrontation is “inevitable” and the others say unthinkable. I must say that I am no expert on this issue, but it would be foolish to exclude this risk of military confrontation in the Korean peninsula. A military conflict is a very bad news for Japan’s national security and prosperity, but the precise impact depends on the size and scale of the conflict. If it is short and small, the impact would be minimal, while if it becomes prolonged and large, it would damage the Japanese economy. One must keep in mind this risk for the first half of 2018, and possibly for the entire year.
2. The new BOJ leadership
In March, the Bank of Japan will have new deputy governors, and in April the new governor. This one month discrepancy is the result of a partisan bickering back in 2008 when the then Democratic Party of Japan blocked the appointments of the BOJ leadership and prolonged the process. This technicality aside, economists and analysts do not see major risk in these appointments. They tend to focus on who will succeed Mr. Kuroda, at the same time the majority seems to bet on his reappointment. But more important fact is the continuation of the current monetary regime. As far as Prime Minister Abe retains his power, which seems likely, he would appoint the new leadership who would continue the current regime.
3. The LDP leadership contest
In September, the Liberal Democratic Party, Japan’s governing party, will choose its new leader, virtually Japan’s Prime Minister. Although some politicians such as Shigeru Ishiba and Shinjiro Koizumi have expressed their interest to join the contest, it is most likely that Shinzo Abe would win its leadership contest. He is the only Prime Minister who won general elections five consecutive times. Even if Abe looks like a shoe-in, here is a risk: his winning crucially depends on the continuation of the economic recovery.
4. Another fiscal policy initiative
Last year Japan got media attention by registering economic growth in seven consecutive quarters, the first time since the mid-1990s. The news is good. However, on closer inspection, the composition of growth is not as good as many commentators. Growth comes mostly from external demand, and domestic demand, especially consumption, is still weak. The consensus view among the commentators is that the so-called “virtuous cycle” would start when corporations begin raising wages due to tightening labor market. But the government can simply put more money into the economy by expansionary fiscal policy, either by an increase in government expenditure or by tax cuts. And as I argue, fiscal policy has been already contractionary. The austerity thinking within the government and the LDP are strong, however. One should expect a political battle over fiscal policy continues.
5. The U.S. monetary policy
A buoyant stock market and the overall good data about the U.S. economy are the biggest factor behind optimism about the global economy. As Seiji Adachi, Director of Economic Research at Marusan Securities CO., points out, the Fed is not really shrinking its monetary base (see chart) last year despite its three-time policy interest rate hikes. So it is still an uncharted territory when the Fed begins shrinking earnestly. The next Fed Chairman Jerome Powell would continue his predecessor’s cautious approach to the exit strategy, but there is a potential big risk.
Last year was the comeback year for China. Compared to 2016 when the Chinese yuan wobbled and the Chinese government was frantically controlling its capital outflow and fighting deflationary pressures, there is now considerable stability and thus optimism about the Chinese economy. But the Chinese economy has several inherent problems. I would skip usual suspects such as ballooning private debt level, and concentrate on macroeconomic linkages between China and the U.S. Suppose the Fed begins shrinking monetary base. As a country which pegs its currency to the U.S. dollar, China has to respond in two ways, either raise the interest rate, or tighten the control of capital outflow. So far China has succeeded in controlling capital outflow, but the risk remain.
7. Other geopolitical risks
North Korea is not the only geopolitical risk. In fact, East Asia has now become one of the most precarious regions in the world. Taiwan is a potential area, and Japan has a territorial dispute with China over the Senkaku islands (known in China as the Diaoyu islands). And do not forget the Middle East where tensions are mounting involving the U.S., Israel, Saudi Arabia, and Iran.
Overall, none of these risks may materialize. But it is always good to think about these risk factors, rather than be surprised at the turn of events.