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Abenomics Failing

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Recently at Jackson Hole, ECB President Mario Draghi announced his own version of the “three arrows” of Abenomics, declaring that the Eurozone needs “a policy mix that combines monetary, fiscal and structural measures at the union level and at the national level.” In effect, he is recognizing that the Eurozone economy is “becoming Japan,” and calling for Japan-like steps to dispel the specter of its own “lost decades.” Unfortunately, Abenomics itself is now failing.

After correctly calling the Japanese recovery as Abenomics began, by last fall we were already warning that, “[m]onths after exiting its sixth recession in two decades, Japan is entering a fresh downturn in growth.” (ICO, October 2013). Since March, that growth rate cycle downturn has been in full force, with Japanese Coincident Index (JACI) growth sliding deeper into negative territory, and approaching April’s three-year low in its latest reading (see chart, showing JACI growth in 1995-97 and 2012-14).

Right after Japan’s sales tax hike, we noted that “[t]he Japanese recovery is clearly running out of steam, as we had expected.”. By May, we were seeing an ominous resemblance between the recent trajectory of JACI growth with that seen around the disastrous 1997 sales tax hike, when the government overestimated the economy’s resiliency, noting that “Japan could be at risk of slipping into a new recession.”

Our array of Japanese indicators affirms the mounting danger of a fresh recession – Japan’s seventh since 1992 – confirming that Japan is proceeding along the recession track, uncannily close to the pattern seen in 1997. Indeed, the main divergence in the current cycle is an unfavorable one, with earnings growth in the current cycle following the 1997 pattern, but distinctly weaker, as earnings have not kept up with inflation, thereby making real earnings growth far weaker than in 1997.

Meanwhile, Japan has become much more export-dependent, with net exports as a percentage of GDP having grown strongly since the turn of the century, and the magnitude of its fluctuations having become larger. So it is a major concern that not only is the domestic Japanese outlook looking just as bad, if not worse, than in 1997, but the trade balance is also now a serious drag on the economy, unlike the situation back then.

This does not preclude an almost mechanical rebound in GDP in Q3 2014, as there was in 1997. The question is what happens after that, and the answer is not likely to be hopeful, judging by the current stance of our key economic indicators.

It is evident that the Eurozone is closer to the low trend growth and deflation danger that have marked Japan’s “lost decades.” U.S. productivity growth has been disappointing, to say the least, in recent years. But its demographics are somewhat better than those of Japan and the Eurozone, and fracking has also boosted U.S. growth and helped to tamp down oil price volatility of late. However, these differences do not negate the fundamentals of “the yo-yo years,” which are based on decades-long declines in trend growth. In fact, the situation in the U.S. is not qualitatively different from those in the other major economies.

That is why Fed Chairman Janet Yellen now admits the possibility that the economy is suffering from some form of “secular stagnation,” where “a negative shock could push economies against the zero lower bound,” and acknowledges that “we will have to worry about these episodes more often.” Prominent central bankers like her and Mr. Draghi have begun to recognize this reality, which is why a version of Abenomics is now on the table in the Eurozone. But, if Abenomics is already failing, it may deal a serious conceptual blow to the mainstream policy narrative that Abenomics (or Draghinomics) is the answer to “secular stagnation,” potentially opening the door to more radical prescriptions.

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