Japanese PM Targets Deflation As The Main Battle

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by: QFinance

By Anthony Harrington

Japan's Prime Minister Shinzo Abe swept all before him in the recent Upper House elections and as reported in the Japanese Times, he lost no time in pledging to focus all his efforts on what has come to be called Abenomics, namely a full-on attempt to create meaningful inflation by throwing everything and the kitchen sink into a sustained wave of Quantitative Easing. In his own words:

"It is not easy to steer Japan out of 15 years of deflation, but we will not have a sound welfare system, national security or diplomacy, unless we have a strong economy."

Abe's LDP party won the Lower House election in 2012 but has been repeatedly seen parts of its economic platform blocked by the opposition in the upper house. The elections have left Abe with complete control of both Houses, the first time any Japanese prime minister has enjoyed this for some six years. He is now free to pursue exactly what he feels the country's economy needs. The results are likely to be fascinating for economists and industrialists alike. High on Abe's list are a series of bills designed to hand out some major corporate tax breaks in an effort to increase competitiveness in Japan's economy.

However, there is considerable concern that Abe's focus on the economy could soften if he starts to get any momentum going for his long term pet project, revoking Article 9 of the Japanese constitution which prohibits the country from waging war. Abe is very keen on revising the country's post-war pacifist stance, a position that is written in stone in Japanese legislation. Abe needs a two thirds public majority to start seriously revising that legislation but his hawkish stance is well known. He wants to strengthen Japan's defence capabilities, at the very least, giving the country the ability to build up the forces necessary for defence.

It is not a posture that makes the rest of Asia feel very comfortable about Abe, and Japan's spat with China over the Senkaku Islands (the Diaoyu islands if you happen to be Chinese) has been condemned around the world as a hugely dangerous piece of sabre rattling by both sides. The subsequent boycott of Japanese goods by Chinese consumers did nothing at all to help Japanese exports so Abe needs to get his priorities straightened out this time round.

The BBC has rather a good "backgrounder" on the origins of the dispute between the two Asian giants over the islands. The history of the islands is murky and complex enough to give both sides reasonable grounds to claim possession. At some stage it is going to require the Judgement of Solomon to resolve this issue without a shooting match (eight small chunks of rock, you have four we'll take four and we split the oil rights, OK? Deal?). China's Ministry of Foreign Affairs has no w said that the issue should be set aside until it can be settled at some future date and that both Japan and China should work hard to prevent the islands derailing their "bilateral ties". Abe's decision to review the possibility of acquiring a pre-emptive strike capability and his government's interest in creating a marine force capable of projecting power to remote islands, pace the Senkaku, doesn't exactly seem likely to help to calm troubled waters.

That said, there is no doubt that the Japanese prime minister is going to have more than enough on his plate if he really does intend to exorcise the demon of deflation. He still has to decide whether to press ahead with the near doubling of the sales tax rate, from 5% to 8%, to take effect in April 2014. The aim here is to do something meaningful about Japan's huge public debt, now over 200% of GDP. Abe's success so far has been to create 3.5% growth for the first quarter of 2013, an eye-popping improvement on the stagnation hitherto, and June's stock market slide saw a revival by mid July, so he has something to show for his efforts. Whether he and his government can hold their nerve this time round (past Japanese governments and the Bank of Japan are famous for taking their foot off the QE pedal at the first sign of potential inflation, thus making themselves a major factor in the continuing resilience of deflationary forces in the country) remains to be seen. The months ahead are going to prove "interesting", that much is certain.