(Reuters) - Buy Japanese stocks if you must but don’t expect Abenomics and the fall of the yen to revitalize Japan’s economy.
The yen has fallen by more than 20 percent since Prime Minister Shinzo Abe, who advocates aggressive monetary and fiscal policy, was elected in December, busting through the 100 yen to the dollar level last week.
In part the theory behind Abenomics is that a weaker yen will revitalize industry, which will export more and plow the proceeds into hiring and capital investment.
The stock market certainly believes: benchmark shares in Tokyo are up 36 percent this year and more than 68 percent over six months.
But a look at the actual data shows Japanese companies, like British ones during a similar bout of currency weakness in 2008, appear to be more eager to use a newly competitive currency to pad profits through higher margins rather than higher export volumes.
Thus far, Japanese exporters appear to be doing just that. Despite yen falls the price of Japanese exports in local currency has barely budged.
“Japanese companies have not actually cut the foreign currency prices of their exports. Just as with the UK exporters, the Japanese have chosen to hold foreign prices constant, maintain market share, and increase the yen value and thus the yen profit associated with yen depreciation,” UBS economist Paul Donovan writes in a note to clients.
This idea, called a “pricing to market” strategy, refers to the strong tendency of exporters of finished products like cars and technology to respond to price pressures from their competitors but not themselves to use a cheaper home currency to cut prices and boost sales.
This was certainly the case in Britain, whose exporters of goods and services used a 24 percent fall in the value of the pound in 2008 and 2009 to boost profits but to hold their export prices essentially unchanged.
Even worse, from the point of view of the Bank of England, which must have hoped cheap sterling would lead to economic recovery, British companies showed a strong tendency to do very little with the extra cash, piling up an additional $40 billion in bank deposits between 2008 and 2012.
If Japan follows that model, Abenomics may in the end succeed in enriching investors but have a disappointing impact on Japanese growth and inflation.
Of course, many of those investors will be Japanese savers, and some, feeling flush with newly valuable portfolios of stocks, may spend more than otherwise they would, helping Japan’s economy in much the way the Federal Reserve hopes quantitative easing will help the U.S.
Still, the Japanese experience with equity booms, and with the bust of the past two decades, is such that it is hard to see many of the country’s aging population going on a buying spree because the Nikkei index has had a few good months.
Still, the extra profits made by Japanese exporters are real, and will have to go somewhere. Donovan of UBS lays out four options.
The first is to stockpile cash, as British companies appear to have done. This is possible, but Japanese companies are already cash-rich in aggregate.
The second is to pay the money out, either as dividends to investors or as higher wages to employees. This would be positive for Japan’s economy, but there is little evidence thus far it is happening.
The third, and this one is the devout hope of the Bank of Japan and the Abe administration, is that some of the money gets plowed into increasing production at home. Why domestic investment would increase in the absence of a pick-up in demand is unclear. Foreign demand for products which aren’t cheaper will depend on foreign economic conditions, while domestic demand will be tempered by an aging population.
That leaves foreign investment as the final, and perhaps likeliest beneficiary of the Abenomics-driven revival in corporate profitability. While there may be some temptation to invest in more capacity at home, especially if corporate executives believe the weaker yen is here to stay, this would be a big reversal of the trend Japanese corporations have followed in recent years. Foreign direct investment out of Japan has doubled in size compared to domestic fixed investment since 2004, and is now actually larger.
Given that there is good demand growth globally for Japanese products, but little of that demand growth can be expected to come from the aging island itself, this makes sense.
Abenomics contains an irony: the effect of its stimulus will be enjoyed in substantial part by hedge fund managers and clients in New York and London and by workers in Japanese factories as yet unbuilt in places like Kentucky.
(At the time of publication, Reuters columnist 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. For previous columns by James Saft, click on)
James Saft is a Reuters columnist. The opinions expressed are his own