Japan's bold Abenomics plan is producing spluttering results on key consumption and investment measures, potentially undermining its resolve.
Japan's economy grew by just 0.3 percent in the fourth quarter, less than half estimates. That's despite Japan and its central bank following through strongly on a massive campaign of asset purchases which is on course to double the amount of money sloshing around the economy in the 20 months to the end of 2014. The Bank of Japan on Tuesday kept policy steady but increased a smaller lending program.
That buying, or money creation binge, has been successful on some fronts: creating the best growth in more than three years and lifting prices decisively.
Japan's consumers and its companies, however, have failed to follow through on their end of a bargain which would create self-sustaining growth and rising prices in Japan.
Put simply, consumers are not spending enough and companies, despite a cheap yen and favorable conditions for exports, seem generally uninterested in making big capital investments to expand.
Without those two groups playing their part, growth may ebb further and Japanese officials will feel less comfortable following through on much-needed structural reforms.
"The growth disappointment poses the risk that these reforms may be delayed or put off entirely and that the authorities will rely on even more monetary and fiscal stimulus for growth in the short-term," Christian Schulz, senior economist at Berenberg Bank, wrote in a note to clients.
"That would seriously increase the risk that Abenomics ends up as an expensive flash in a pan which would leave Japan with no materially improved long-term growth outlook, but even higher public debt by the time the stimulus ends. In the worst case, it could even set off a devastating inflation-devaluation spiral."
These structural reforms, known as the so-called "third arrow" of Abenomics, after public spending and massively expansionary monetary policy, are aimed at reducing the fiscal burden, loosening the labor market and making it easier to start and operate a business.
The first two arrows are pleasant, even fun. Spending money employs people and spreads funds around, something everyone loves, while massive "QE" drives up the prices of financial assets, making it a crowd-pleaser.
Reform, unfortunately, steps on a lot of toes and opens lots of divisive arguments - such as on immigration - and to carry it out well Prime Minister Shinzo Abe is going to need better results from his first two arrows.
FAITH IN THE FUTURE?
Abenomics has succeeded in pushing up prices, an achievement not to be dismissed in a country which has struggled with deflation for decades.
But while prices are up 1.3 percent in the past year, total earnings by Japanese workers are up just 0.8 percent. Even worse, what gains there are in earnings are coming not from permanent rises in salary as much as one-off bonus and overtime earnings. The net-result is a lukewarm 2.4 percent rise in private consumption.
Quite naturally, that is leaving many Japanese feeling pinched and vulnerable. A Bank of Japan survey of public opinion released last week, showed a rising number of people believing their income had fallen in the past year and a similar rise believing it would fall in the coming year. Even more striking in a country where deflation has been crippling, more than 80 percent saw the rise in prices last year as being "unfavorable".
And all of this is before a planned increase in sales tax this April which should further limit the growth in demand.
On the corporate side companies are investing, but a 1.3 percent rate of capital investment growth is far shy of what one would expect during a typical economic recovery.
While a weaker yen should make Japanese exports more competitive, to get a lasting benefit from the situation Japan needs its companies to gear up in response, increasing capacity, hiring new workers and creating a virtuous cycle.
Last quarter, that didn't seem to be happening, perhaps due in part to a mini-crisis in emerging markets, but also perhaps in part because corporate managers lack confidence about the future.
"Despite business surveys' strong approval of Abenomics, Japanese companies appear to be reluctant to step up their investment in Japan. That may be because they see better locations for their investment outside Japan, or simply because they continue to view the future as uncertain," Stephen Lewis of Monument Securities wrote in a note to clients.
A weak yen may be seen as a short-term opportunity for companies to harvest fat, low-risk profits, but not as the spur to making longer-term investments.
The circle in Japan will either be virtuous or vicious.
If companies and individuals spend and invest they'll create growth and room to make reforms which will justify that spending and investment, and allow Japan to outgrow its very high public debt.
If they don't spend and invest, those reforms, never fun, may never have much of a chance.
(The views expressed here are author's own.)
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft)