Japan’s ¥2.49 trillion trade deficit in 2011 — its first in 31 years — tells you where the economy’s development stands in relation to the balance of trade. Let’s review how the trade balance has fluctuated in each stage of the nation’s postwar development and look at some of the challenges ahead.
In the first stage, which lasted up to the 1960s, Japan was an “immature debtor country.” It suffered from a trade deficit and a shortage of domestic savings, forcing it to rely on foreign capital.
The second stage saw Japan turn into a “mature debtor nation.” Export industries grew and the country started to post trade surpluses, though it still has external debts and its income balance remains in the red. This stage began in the 1960s, when trade surpluses became the norm for Japan, and continued until the 1970s, when upward pressure started to build on the yen’s exchange rate.
In the third stage, Japan is in the process of repaying its external debt. The trade balance surplus exceeds the income balance deficit, making current account surpluses the norm through the 1980s.
In the fourth stage, Japan becomes a “mature creditor country,” which is where it stands today. By international comparison, it has become costly to do business in Japan, and companies are being pushed to increasingly shift operations abroad, again tipping the trade balance into a deficit. Still, the nation has a substantial surplus in the income balance, and thereby continues to run a current account surplus.
In the fifth and last stage to come, Japan will start to consume its own assets. The trade deficits will eclipse the income surplus and tip the nation into a current account deficit. It will be just like an individual who spends more than he earns each month and taps into his savings to pay for the deficit. If his savings run out, he will need to cut back on daily expenses — the same challenge confronting the Greek economy.
The challenge for Japan is to improve its economic productivity and structure to remain in the fourth stage as long as it can — and brace for the day it enters the fifth stage. Here, I would like to put the problems into a currency-exchange perspective and view the issues from two angles — a trade balance and an income balance.
From the viewpoint of a trade balance, many people will advocate the benefits of a weak yen. To get a correct understanding of the situation, however, we need to look at the realities of which currencies are used in Japan’s trade contracts.
In the first half of 2011, 48.8 percent of Japan’s export contracts were made on a U.S. dollar-denominated basis, 40.3 percent in yen and 6.4 percent in the euro. For Japan’s import contracts, the dollar accounted for 72.4 percent, the yen 23.1 percent and the euro 3.1 percent.
The dollar’s dominant share of the import contracts is due to the fact that many of the key international commodities, such as crude oil and wheat, are traded in the dollar. When trade statistics are adjusted on a foreign currency basis, Japan is revealed to have had a trade deficit for some time now. Furthermore, from the viewpoint of Japan’s salaried workers, who cannot expect much in the way of a wage increase, a stronger yen will be favorable because it offers better international buying power.
From the viewpoint of an income balance, as long as the interest rates on the yen stay as low as they are today, returns on foreign currency assets will be higher. However, a strong yen will result in capital losses.
On the other hand, a rise in the yen’s interest rates will cut the margin of return on foreign currency investments, while simultaneously squeezing yen-converted returns on foreign currency assets. This shows that for Japan — in its current stage of economic development — the benefits and disadvantages of currency fluctuations will emerge in different ways when Japan has a trade balance or an income balance.
As the graying of Japan’s population advances, we will eventually have to tap our savings. And that is why we save in the first place.
To make the best use of our savings, the government, private-sector companies and households will all need to determine what the best mix of domestic — or yen-denominated — assets and overseas — or foreign currency-denominated — investments is to prepare for the fifth stage of economic development.
Teruhiko Mano is an international economic analyst.