The expert’s estimates of when Japan will transition from being a net creditor into a net deficit nation vary widely. Those at the long end typically discount Japan’s 2011 trade deficit as being caused by one-off events. They believe, as does BOJ policy board member Hidetoshi Kamezaki, Japan holds a huge cushion of overseas assets it can rely on to finance the trade deficit for years to come. UBS, at the long end, is predicting that Japan will be in current account surplus well past 2050 (see FT article). Jesper Koll, Managing Director and Head of Japanese Equity Research at JPMorgan Securities Japan, thinks differently. He believes the turning point is imminent. I caught up with J. Koll over coffee earlier this month to ask him why there was such wide variance in current account forecasts, to find out what the key driving variables were, and to determine what hard facts his own predictions are based upon. This is the second part of a two part interview (first part here).
R. Solomon: Jesper, why do the expert’s projections as to when Japan will become a net debtor nation differ so widely?
J. Koll: Everyone agrees that because of the demographic destiny of Japan, the country is going to run out of savings. There are always gyrations and business cycles, so the exact timing is where the forecasts vary the most. I’m in the camp that believes the time has come. The fundamental driver of both exports and imports is pointing in the direction of the trade deficit that we saw for the first time last year since 1961. I believe the trade deficit is going to continue to grow. Over the next two years the trade deficit will be so large that the services account surplus is going to be eroded as well. It is coming…. it’s here. It’s “Sayonara Japan” as a net creditor country.
R. Solomon: Everyone agrees that the trajectory of the current account is pointed downwards. But their timing estimates as to when it turns negative stretches over many years. That predictions are all over the place suggests that supporting evidence has been anecdotal rather than quantitative. Is there a lack of timely, accurate or relevant data?
J. Koll: There is nothing wrong with the data. There are a couple of variables that go into it. What most people are ignoring is the unbelievable deterioration in the terms of trade… that is, the price of exports relative to the price of imports. That has been declining on average 5.5% per annum for the last decade. That’s a tremendous cost.
What’s happening is simple and straightforward. On the export side, it’s very difficult for Japanese companies to get any form of pricing power in global markets. That’s not because of the exchange rate. That’s because there is competition on more of the products Japan exports. There is increasing competition, for example, from Korea, Germany, and the rest of Asia. Take a look at the automobile industry. Japan Inc. has built some very fine luxury cars. But now so does Hyundai. I think that, regardless of whatever the exchange rate is, the ability of corporate Japan to raise export prices is being curtailed. The future (of its ability to raise export prices) is even more questionable.
On the other side of the equation, import prices are a very simple and straightforward function of commodity prices. If you believe that global growth is primarily driven by the so-called BRIC countries whose resource pull puts upward pressure on oil, gas and other commodities, then Japan’s import bill will continue to increase.
Every year Japan is losing somewhere between 2 – 3 trillion Yen worth of price power on its trade account. If you project that out in about two years time, the increase in Japan’s trade bill will wipe out the surpluses it generates on its overseas assets. This of course is the other side of the current account.
So the time is now. There are a lot of people arguing that last year the trade deficit was just a one-off. They claim, “It was a one-off because exports were disrupted by (the floods of) Thailand, by the events of March 11, and the increased commodities import bill from Japan’s forced de facto exit from nuclear production.” Well, I ask, is that really a one-off? Have any nuclear reactors restarted? More importantly, since March 11 corporate Japan has made the decision to aggressively invest in overseas growth. So the so-called hollowing out of Japan (kudouka), is actually accelerating. To be specific, about 55% of the productive capacity of Japan’s automobile industry is currently outside Japan. The Industry’s plans put into place since March 11 will increase that figure to almost 80% by 2015. So your export elasticity, in other words the gearing of Japanese export growth into global growth, is going to come down because more of the global demand and growth will be satisfied through overseas production (genchi sesan). Yet it’s perfectly rational for Japanese companies to do this because outside Japan is where the profit margins are. That’s where the markets are.
R. Solomon: Will not the income earned from Japan’s overseas assets counter the effects of an increasing trade deficit?
J. Koll: The bulk of the income account is actually income generated from fixed income instruments (rather than on dividends earned from Japan’s productive overseas assets). If interest rates start rising, then the interest income is going to be growing a little bit. But if you look at the component parts, the income account is not so important. The underlying pressure is being generated from what’s happening on the trade front. In this regard, Japan’s import bill will keep on growing while its export pricing power will continue to erode.
R. Solomon: What other key variables adversely affect the current account?
J. Koll: There are two key variables. The first concerns global growth. We are predicting that global growth will be 3% – 3.5%. If, however, global growth is stellar and climbs back to 4 – 5%, then you will obviously get greater demand-pull for Japanese exports. That will add another year to our projections as to when the trade deficit becomes larger than the income surplus. The second variable is commodity prices. If you think commodity prices are dropping, for instance if oil goes back to the $60 – $70 range, then Japan’s import bill is going to be much smaller. These are the two key variables.on of overseas assets of which it can rely to finance its trade deficits for many years to come, how do you respond to such claims?
J. Koll: The income account is not huge. It is only 2% of GDP, almost nothing. Many people are holding onto the incorrect belief that Japan’s overseas financial assets will allow it to remain in current account surplus for a long time. To these people I say, “well watch out,” because the widget economy for goods and services is way more important than the interest income that you actually earn. As anyone who has ever tried it, living off your assets is a very difficult thing to do.
Jesper Koll, Managing Director and Head of Japanese Equity Research, JPMorgan Securities Japan Co., Ltd.