Japan may be at the start of a new chapter in the country’s postwar story.
Price and wage rises indicate that “the economy is reaching a turning point in its 25-year battle with deflation,” according to the Japanese government’s recently released annual economic white paper.
After decades of stagnation and deflation, Japan has entered a period of persistent inflation. Consumer spending is rising. Exports have been booming, save for a small late-summer slip.
The Japanese economy’s strengthened position stands out in sharp contrast to a world grappling with comparably anemic growth prospects. As the tables turn, how will a resurgent Japan upend the investment landscape?
Making sense of one of the world’s most perplexing economies can be dizzying. The Japanese economy—an outlier that has held fast to its monetary-stimulus measures—has existed in its own dimension, in which even small policy shifts can cause wider turmoil.
When the Bank of Japan loosens its grip on yields, expectations of more drastic policy changes—and a shift to normalization—send global markets into flux.
When it comes to the upside-down world of Japan, it’s imperative that investors challenge their assumptions and shift their perspectives, says Magdalena Polan, Head of Emerging Market Macroeconomic Research at PGIM Fixed Income.
“Don’t look at the flashing light—you’re going to miss the big picture in Japan,” Polan says.
She asserts that while investors are fixated on Japan’s monetary policy story, the more interesting story is one of structural reform. As Asia-focused global investment steers away from China, a number of factors may now be aligning in favor of the world’s third-largest economy.
THE Upside / Downside
GLOBAL ECONOMY
DOWNLOAD REPORT
In a time of
unprecedented DOWNSIDE,
Imagine the UPSIDE.
download report
I think in Japan,
we have a chance for
a significant structural break. They will finally wake up from their post-World War II slumber.”
MAGDALENA
POLAN
Head of Emerging Market Macroeconomic Research, PGIM Fixed Income
JAPAN'S ECONOMY SURGES AHEAD
Can Japan Find the Path Back to a Dynamic Economy?
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Sources: Ministry of Finance Japan, Rengo, Bank of Japan (July 2023)
15.5
%
in fiscal 2022
THE
CHALLENGE
Corporate reforms are helping to drive the Japanese stock market to its highest levels since the start of the 1990s, when the country began to slip into its Lost Decades.
During those years of cost-cutting and stagnant wages, returns for shareholders and raises for employees were rare. But there’s been a shift in how Japanese companies—notoriously resistant to management changes—are run.
Earlier this year, Uniqlo promised workers raises of up to 40%. Shareholders at Canon demanded diversity among its male-only board of directors. Citizen Watch announced it would repurchase a quarter of its shares. The Tokyo Stock Exchange implored companies to pay closer attention to their market valuations and increase shareholder returns.
With a weak yen and ultra-low interest rates, it’s little wonder why investors like Warren Buffett are pouring foreign cash into Japan.
Shigeto Nagai, Head of Japan Economics at Oxford Economics, has been most surprised by the shift in the corporations’ price-setting behavior.
“There’s been a fight with this disinflationary equilibrium for decades, which is characterized by very cemented price setting,” says Nagai. “But recent unprecedented shocks have really changed price-setting behavior. They might have been released from this perception of, if you’re going to raise prices, you’re going to lose.”
Nagai says that some companies with known price competitiveness, like Uniqlo, have found that even in this Japanese macroeconomic environment, they can keep raising prices without losing market share.
Investors wondering if there have been fundamental market shifts in Japan or if this is merely another false dawn in Japan must consider all the current shifting dynamics, starting with the collapsing yen.
“Can the yen weaken further? It can,” says Gerwin Bell, Lead Economist for Asia at PGIM Fixed Income. “I think they would try tooth and nail in order to prevent that. So we get massive intervention, massive new buying again. And they have shown us that they have no problem essentially destroying the entire liquidity in the JGB [Japanese government bond] market; that's fine with them. So, I would take them at their word that they will not tolerate excessive FX moves.”
The yen is likely to strengthen if—and when—the Bank of Japan unwinds the country’s ultra-loose monetary policy. Some onlookers have pored over Bank of Japan Governor Kazuo Ueda’s every word for hints on when that moment will come, but Nagai says that despite the tumbling yen and stubborn inflation, the move to normalization will be gradual.
THE
IMPACT
When Polan looks at Japan, she sees a country at an inflection point. The current geopolitical situation is forcing Japan to consider new economic approaches, and there are signs, Polan says, that the working-age population in Japan could be poised to increase due to a rise in immigration.
“The last 20 years, they’ve wandered along like Europe,” she says. “They can do better. They can get back to a more dynamic Japan.”
US-China tensions are creating a moment of grave uncertainty for the world. For Japan, it’s also a moment of immense opportunity that requires a new outlook, says Polan.
“You have to become active, and you have to become comfortable spending and being assertive—and being a regional leader,” she says.
THE
TAKEAWAY
This is a puzzling moment in the US. It is a very perilous one for China. That makes this a very uncertain moment not just for the two countries, but the world.”
Senior Fellow,
Brookings Institution
Eswar Prasad
in spring of 2023, the biggest hike for union workers since 1993
%
3.58
in Q2 2023
%
14.9
EXPORTS
WAGES
FOREIGN DIRECT INVESTMENT
in spring of 2023, the biggest hike for union workers since 1993
%
3.58
wages
in Q2 2023
%
14.9
FOREIGN DIRECT INVESTMENT
In Japan’s case, investors fixated on monetary policy narratives are at risk of missing the market effects of dynamics like the West’s evolving relationship with China.
“Decoupling has been really restraining profit opportunities,” says Nagai, of the effects on Japan of Chinese de-risking. “And I think, increasingly, more Japanese companies have to give up business opportunities. Consumption goods are also a very attractive market for many Japanese companies. And if that consumption continues to be stagnant, that is bad news for Japanese exporters.”
But chip wars and “friend-shoring” can ultimately work in Japan’s favor.
“Japanese companies will take advantage of friend-shoring to internationalize the markets and business,” Nagai says. “Decisions have been made in the Japanese way. But I think this increasing collaboration with other capitals in terms of defense, decarbonization—it could really change the corporate culture, which is very, very helpful to raise the productivity of this economy.”
Corporate reforms are helping to drive the Japanese stock market to its highest levels since the start of the 1990s, when the country began to slip into its Lost Decades.
During those years of cost-cutting and stagnant wages, returns for shareholders and raises for employees were rare. But there’s been a shift in how Japanese companies—notoriously resistant to management changes—are run.
Earlier this year, Uniqlo promised workers raises of up to 40%. Shareholders at Canon demanded diversity among its male-only board of directors. Citizen Watch announced it would repurchase a quarter of its shares. The Tokyo Stock Exchange implored companies to pay closer attention to their market valuations and increase shareholder returns.
With a weak yen and ultra-low interest rates, it’s little wonder why investors like Warren Buffett are pouring foreign cash into Japan.
Shigeto Nagai, Head of Japan Economics at Oxford Economics, has been most surprised by the shift in the corporations’ price-setting behavior.
“There’s been a fight with this disinflationary equilibrium for decades, which is characterized by very cemented price setting,” says Nagai. “But recent unprecedented shocks have really changed price-setting behavior. They might have been released from this perception of, if you’re going to raise prices, you’re going to lose.”
Nagai says that some companies with known price competitiveness, like Uniqlo, have found that even in this Japanese macroeconomic environment, they can keep raising prices without losing market share.
Investors wondering if there have been fundamental market shifts in Japan or if this is merely another false dawn in Japan must consider all the current shifting dynamics, starting with the collapsing yen.
“Can the yen weaken further? It can,” says Gerwin Bell, Lead Economist for Asia at PGIM Fixed Income. “I think they would try tooth and nail in order to prevent that. So we get massive intervention, massive new buying again. And they have shown us that they have no problem essentially destroying the entire liquidity in the JGB [Japanese government bond] market; that's fine with them. So, I would take them at their word that they will not tolerate excessive FX moves.”
The yen is likely to strengthen if—and when—the Bank of Japan unwinds the country’s ultra-loose monetary policy. Some onlookers have pored over Bank of Japan Governor Kazuo Ueda’s every word for hints on when that moment will come, but Nagai says that despite the tumbling yen and stubborn inflation, the move to normalization will be gradual.