Commentary / Japan

Japan in 2018 — 10 possible surprises

by Jesper Koll

2018 is poised to be a good year for Japan. As rising confidence at home gets compounded by accelerating global growth, a 3 percent GDP growth would not be a surprise according to my econometric models. Real surprises are true outliers, scenarios not captured by the quantitative forecasts of the experts, or the consensus opinion of the crowd. That’s what makes surprises so powerful.

For Japan in 2018, here are the outlier scenarios that I personally worry about. Improbable as they may appear, any movement toward their far-out direction will force an about-face in consensus opinion. Enjoy, and best wishes for a successful and happy 2018.

Prime Minister Shinzo Abe goes to Pyongyang and secures a $1 trillion Japan-led infrastructure upgrade for North Korea.

At the start of 2018, it may not be prudent to expect a reversal of fortunes on the North Korea issue. However, as long as cool heads prevail, the path toward a constructive endgame is not impossible to foresee.

For an economist, North Korea and Japan are a match made in heaven: an ample supply of natural resources and labor meets world-leading technology and capital. Prime Minister Shinzo Abe has an outstanding track record as a champion promoter of Japan-led infrastructure projects. Engaging North Korea constructively would not just boost Japan’s economic fortunes, but surely create a historic legacy for Abe worthy of the Nobel Peace Prize.

Unlikely, unfortunately; but so is a peaceful endgame solution without stepped-up economic engagement. Sooner or later this will happen, in my view.

Accelerated yen depreciation toward 150 to the dollar forces China to devalue the Chinese yuan by 30 percent.

De-synchronized monetary policy cycles raise the probability of de-synchronized asset price movements in general, foreign exchange market overshoots in particular.

In my view, this leaves the yen very vulnerable for 2018. As the dollar gets stronger, China is the circuit breaker I am most worried about. Japan and China now compete head to head in more markets and products than Japan does against the United States; so yen depreciation is now more of a worry for China’s factories than for U.S. ones.

The weaker the yen gets, the greater the risks of a yuan devaluation: when the yen slips past 140 to the dollar, I fear a 30 percent yuan devaluation.

The new Federal Reserve chairman imports the Bank of Japan operational model and fixes the U.S. 10-year yield at 2.5 percent.

If U.S. President Donald Trump gets his wish and the U.S. economy speeds up to a sustained 3.5 to 4 percent growth rate, U.S. bond yields could rise to as high as 6 percent. (They’re currently around 2.5 percent).

Before long, rising bond yields will be followed by a recession. To pre-empt this, a professional real estate developer and very unorthodox president may find it hard to resist the temptation of getting the Federal Reserve to import the BOJ operational model: Fix the U.S. long bond at an agreeable level, say 2.5 percent, and let the economy go into overdrive for the next election cycle.

Toyota buys Tesla and turns the newly integrated U.S.-based factories into the most productive car factories ever.

Toyota and Tesla are perfectly complementary. Toyota is the global champion of top-quality mass-scale manufacturing, which is Tesla’s weakest point; but Tesla offers a turbocharged on-ramp to the future of transportation, which is exactly where Toyota wants to get to. One can easily imagine Toyota-led production expertise delivering the world’s most productive car factories for Tesla.

A Japan champion buying a Silicon Valley superstar would be a huge surprise. The more likely strategy is for Toyota to come from behind and beat Tesla at its own game. Out-producing and out-designing a first-mover like Tesla is, after all, Japan’s proven core competence.

Abe introduces “Asia-Coin,” the world’s first central bank-backed blockchain cybercurrency.

The race is on for national governments to launch an official cybercoin standard. Japan could take the lead by introducing a BOJ-backed “Asia-Coin,” a blockchain-based currency system created by a consortium of Japan’s mega-banks and the BOJ.

As a new national policy initiative, Japan’s leading companies would then adopt “Asia-Coin” as their settlement system for their global transactions, which would in turn create a virtuous cycle of trust, liquidity and, well, a head start for Japan to set the global standard for the future of banking.

And the race really is on: While concerted Japan leadership would be a positive surprise, a China government-led cybercurrency is bound to be launched before long.

Japan introduces “financial means testing” to cut public benefits and national health care for wealthy individuals.

Cutting public benefits and entitlements is unpopular anywhere; but in Japan, it is still popular to tax the rich and redistribute incomes.

The runaway fiscal deficit forces new thinking on how entitlements can be cut. “Financial means testing” could be one option, where, for example, anybody with net financial assets greater than, say, ¥10 million, and no mortgage debt, is no longer eligible for the public pension or national health care.

Controversial for markets, but popular with voters? Just don’t be surprised by the creativity of Japanese policymakers.

Japan joins the China-led Asian Infrastructure Investment Bank.

Both Japan and China have emerged as Asia’s champions for multilateralism. Joining forces to lead by example makes more and more sense. Japan joining the China-led Asian Infrastructure Investment Bank would be symbolic of both Japan’s growing independence and her commitment to multilateralism.

An even bigger surprise would be a truly grand strategy: in exchange for Japan joining the AIIB, China joins the Japan-led Trans Pacific Partnership free trade initiative.

Tokyo real estate prices surge past 1990 bubble-peak levels.

Tokyo real estate prices still remain a good 40 to 50 percent below 1990-1991 bubble peak levels. In 2017, developers became more aggressive. Here and there, luxury apartments for $5 million or $6 million are coming onto the market, which is more than double the price of top deals done three years ago.

As demand is fueled by a new group of Japanese entrepreneurs, easy credit availability, and Asian buyers, it won’t be long before a new record price will be set. By 2020 this must be expected, but if it comes in 2018 it would be high-profile confirmation that deflation is over.

Bio-tech, “fintech” and AI startups lead a wave of IPOs that establish Tokyo as Asia’s premier applied innovation hub.

Nothing succeeds like success. For years now, the Japanese government has been focusing on the need for more entrepreneurship, innovation and corporate creativity.

The time has come to actually show concrete success. A wave of initial public offerings would do wonders to prove Abenomics is working, that Japan is back on track to become the innovation power hub in Asia.

Japan beats Germany to win the 2018 World Cup.

July 15 brings the FIFA World Cup final. Japan winning the title would be a major surprise, particularly to me. After all, I am German and, every four years when the World Cup is held, I cannot help but turn massively biased. Team Germany not making it to a World Cup final will not be just a surprise, but a real shock. May the best team win in 2018 !

Jesper Koll is WisdomTree’s Head of Japan. Researching and investing in Japan since 1986, he’s been consistently ranked as a top Japan strategist/economist. He publishes blogs at www.wisdomtree.com/blog .