Commentary / Japan

Japan in 2019: 10 surprises

by Jesper Koll

2019 is poised to be a good year for Japan. While worries about U.S. and China recession risks create global headwinds and uncertainty, domestic Japan is well placed to de-couple from the global cycle and deliver rising employment and increased purchasing power for its people. There are, however, bound to be surprises, i.e., scenarios not captured by the quantitative models of the experts or the consensus opinion of the crowd. For Japan in 2019, the following are the outlier scenarios that I personally worry about. Improbable as they may seem, any movement in their extreme direction will force a true about-face in the current consensus. That’s why surprises are so powerful. Enjoy, and best wishes for a prosperous and happy new year.

The 2019 shunto wage negotiations result in a 4 percent pay raise, up from the 2 percent delivered last year.

Japan’s economy needs a more powerful engine to drive domestic consumer spending. After years of wage restraint and company unions preferring long-term job stability to short-term wage gains, the labor market has now gotten so tight that wage growth should start to accelerate. If I am right and the 2019 shunto results in a de-facto doubling of last year’s pay hike, consumption-led growth could become a reality. The higher the wage hikes, the greater the chances of Japan de-coupling in a positive way from a global downturn.

Prime Minister Abe convinces China to join the Trans-Pacific Partnership.

2019 is poised to bring an inflection in Japan-China relations. After their successful summit in October, Prime Minister Shinzo Abe and Chinese President Xi Jinping are committed to not just improved bilateral relations, but also to assert a more credible joint leadership role in Asia. For China, nothing would demonstrate a true commitment to accountable Asian leadership better than it joining the multilateral TPP free trade agreement, now formally known as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership. For Japan, bringing China into the TPP would elevate its status as global leader and protector of multilateral rule-making. Moreover, Abe would go down in history as the statesman who built a positive buffer for all Pacific nations against their fear of the unilateral rise of China — cooperative engagement, not unilateral submission.

The United States moves from a trade war to a currency war as the Federal Reserve is forced to cut U.S. interest rates.

As U.S. recession risks rise, the probability of a U-turn in U.S. interest rate policy goes up. After four rate hikes in 2018, the Fed could actually start cutting rates by summer. In turn, U.S. rate cuts will forcefully push down the dollar. Unfortunately, neither China nor Europe are in a position to tolerate this. China in particular is already very outspoken in its opposition to a new version of the Plaza Accord (in which Europe and Japan in 1985 agreed to a U.S.-imposed weak dollar policy). Make no mistake — the next U.S. recession is poised to trigger a global currency war, i.e., competitive devaluations. Importantly, it is no longer the U.S.-Japan exchange rate but the U.S.-China exchange rate that will dictate global fortunes in 2019 and beyond.

A Japanese mega-bank buys a major U.S. bank.

Some good news for Japan: The fall in the U.S. stock market has lowered the price to buy American companies. Japanese banks have been eager to expand in the U.S. but were put off by the high prices and valuations of U.S. banks in the past couple of years. Now that the U.S. cycle has turned, Japanese bank CEOs may finally get their chance to act out their strong global ambitions and buy a “cheap” U.S. bank in 2019.

The Bank of Japan and the Finance Ministry cooperate to sell the BOJ’s ETF equity holdings to Japanese savers.

The BOJ owns almost 6 percent of the Japanese equity market through its exchange-traded fund-buying program. While justifiable as an emergency measure to help overcome deflation, the central bank’s de-facto nationalization of equity capital has become counterproductive for many reasons. The biggest one is that nobody can conceive a smooth exit: If the BOJ starts selling, surely the market will crash. Who is there to buy the BOJ equity overhang?

There is only one answer: Japanese savers in general, the older generation in particular (people over 65 own more than 70 percent of the net financial assets). To get an elderly saver to swap from bank deposits to risky ETFs will require a real incentive: inheritance tax. If the BOJ and the Finance Ministry can cooperate and devise a scheme in which any individual who buys ETFs directly from the BOJ will have these ETFs exempt from inheritance tax, I am certain the central bank could clean up its balance sheet within a couple of weeks. The net result would be a re-privatization of Japanese equities, a healthier corporate ownership profile and a better risk-return profile for household-sector balance sheets.

A “flying car” shuttle service for the 2020 Olympic medal winners is announced by the Tokyo governor and Toyota.

The Tokyo Olympics want to showcase Japan’s innovation power. In 1964 it was the shinkansen; in 2020 it could be flying cars. Watch for the governor of Tokyo and Toyota Motor Corp. to announce a flying car shuttle service for 2020 Olympians in general, medal winners in particular. For a true quantum leap in mobility forget self-driving ground transportation — flying cars could become Japan’s next big thing.

The Liberal Democratic Party commits to a “no more tax hikes” policy.

In 2019, the consumption tax will rise from 8 percent to 10 percent on Oct. 1. A positive surprise would be Team Abe and the Liberal Democratic Party committing to a policy of no more tax hikes before the 2019 Upper House election. Clearly, nothing depresses consumer confidence more than prospects of taxes going up again and again. A “freeze at 10 percent” pledge from the LDP would boost the credibility of self-sustaining consumer-led growth. It would also empower post-Abe LDP leaders to restrain runaway budget deficits by cutting expenditures and privatizing government services.

Japan’s public and private pension funds commit ¥1 trillion to a joint incubator fund.

Innovation and entrepreneurship are on everyone’s agenda, but little concrete action is taken to create a more entrepreneurial culture. It’s a complex issue, but a sure way to start is to offer funding for startups. A public-private partnership incubator fund, in which both the public and private pension funds commit to ¥1 trillion of investments in domestic startups, should help develop a new ecosystem. Ironically, the biggest obstacle here appears to be not a lack of credible startups and entrepreneurs, but the lack of professional expertise among Japan’s pension managers and other institutional fiduciaries.

A peaceful invasion of Taiwan is launched, with 100,000 Chinese arriving by boat to settle there.

War scenario games continue to evolve, but a very real threat could come from neither hard weaponry nor cyber hackers. In the case of Taiwan, a “peaceful invasion” may unfold, with a fleet of, say, 100,000 mainland Chinese arriving by private boats with the intention of settling in Taiwan. Surely this would be an incredible test of the “One China” policy and a potential game-changer in South China Sea geopolitics.

Japan’s rugby team makes it to the finals of the 2019 Rugby World Cup.

The host team of the 2019 Rugby World Cup is poised to fight for honor and country. Wouldn’t it be poetic justice if the Brave Blossoms go all the way in the first Rugby World Cup of the new Imperial era? Ah, to dream is always so much better than to be surprised.

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