Japan's Trade Deficit Balloons

Japan's trade trends continue to weaken as its deficit rose again in June and as the trend for the deficit continues to worsen from 12-months to six-months to three-months. Twelve-months ago, the trade position was in surplus. That's now a thing of the past.

The trends clearly showed that imports are stuck at a very high growth level well above that for exports; exports are trendless and fluctuating in much lower range of growth. Imports fluctuate in a higher range of growth and show some signs of accelerating.

Not surprisingly, during this period the yen has been weakening and weakening sharply; the yen is off by 21.7% over 12 months, it's falling at a 38.5% annual rate over six months and at a 62.9% annual rate over three months. A weaker yen makes imports more expensive at home and exports cheaper abroad. More expensive imports should cause consumers to buy fewer of them while cheaper exports should increase Japan's export penetration. On balance, the weaker yen should work to correct Japan's widening trade deficit. That, of course, is in theory.

In practice, the weak yen creates some problems for Japan. One is that the weaker yen makes oil imports even more expensive. In the short run, it's hard for consumers to substitute away from an energy source. To the extent that the weak yen causes the yen price of oil to rise sharply, the Japanese trade balance expressed in yen terms will widen for some time. Eventually consumers may find a way to cope with higher energy prices… to use more insulation, to buy more fuel-efficient cars, and so on. In time there is a price elasticity for energy products and energy consumption can be reduced. In Japan, however, there is a move afoot to recommission shuttered nuclear power plants. In the wake of Japan's nuclear disaster, they were all being decommissioned. But now in the face of global warming and high global energy prices, Japan is extending the commission on some plants that had been scheduled to be closed and making plans to open others. This could help to reduce its energy bill.

We can see the impact of the currency shifts on Japan prices as import prices are up by 46.2% over 12 months, up at a 58.8% pace over six months, and up at a 110.7% annual rate over three months. The weaker yen is pushing import prices up strongly. However, export prices also show substantial life, rising 18.8% over 12 months, at a 28.1% pace over six months and at a 40.1% pace over three months. The weakening yen allows Japanese exporters to raise their yen price and still to cut their export price in foreign currency terms. This is another way that a weakening currency helps to right the trade balance. Exports get a double boost because prices in the export market fall in foreign currency terms and through the effect of price elasticities that should cause the volumes purchased to rise more sharply. At the same time the yen prices are rising and so this can have a very positive effect on export prices and on export values.

Because prices move in advance of volumes, there is something called A ‘J-curve’ that reflects the fact that after a currency falls the trade balance often gets worse before it gets better sketching out a pattern of the letter ‘J’ lying face down. This mostly because of imports have prices rising before consumer react to buy fewer imports so total import value rises after a currency depreciates – note the rapid increase in Japan import values.

So far, the impact on real flows isn't discernible; exports are still weak across all horizons, down by 0.4% over 12 months, down by 3.5% at an annual rate over six months and down at a 2.1% annualized pace over three months. Real imports fall by 2.3% over 12 months, rise at a 5.7% annualized rate over six months but then fall at a 5.4% annual rate over three months. The impact of the currency rate change has yet to set in on trade flows.

In addition to trade flows, there’s a question about demand. Global economy is weakening; demand is weakening globally. Japan right now has the misfortune of exporting to two economies that are having slowdowns. Japan's largest trade partner, China, continues to see COVID spread but continues to run a zero COVID policy and implements lockdowns to try to restrain the spread of COVID. China also has a severe housing sector problem that may be introducing political backlash into its economy and its operation. Japan’s second most important trade partner, the United States, also shows growth fading rapidly. The U.S. logged a negative GDP result for the first quarter. So far, economic data in the second quarter have been weak and uneven. Some are saying the U.S. may be in recession already. However, the climb down for GDP in the first quarter occurred with very robust consumer spending and was caused by less inventory investment and a sharp widening in the U.S. trade deficit. These are not classical signs of recession. Especially not the part with consumer spending running very strongly. However, consumer spending in the U.S. is now slowing and other aspects of the economy are slowing. Industrial indicators have beginning to flash warning signs as well.

All these factors point to how this is a transition time for Japan's economy and for the global economy. The European Central Bank just met and raised rates for the first time in this cycle hiking its key rate by 50 basis points, a hike that was larger than expected. Global inflation is high and central banks are taking steps to redress this, but they have not acted early; they've acted late. Meanwhile, the conflict between Russia and Ukraine continues as hot as ever. That war continues to pressure supply lines, commodity prices, and threaten food supplies. In short, the outlook remains quite troubled. China is having economic problems. The United States clearly is slowing and is probably headed for recession. The same is true of Europe. Central banks are not in a position to head off this recession because they're aimed at slowing the inflation that they let get out of control. The next year or two are going to be years spent redressing some of the mistakes that were made over the past several years partly because of a misplaced sense of how to deal with a pandemic that was not even as risky as it was made out to be. China continues to tilt at windmills.