Year of the Dog reflections: Fraud compounds Japan’s inflation failure

At the beginning of every Chinese New Year, AsianInvestor makes 10 predictions about economic, political and financial developments that are likely to have an impact on the way institutional investors assign their money. And then, one year later, we revisit these forecasts to see how well we did.

Our fifth Year of the Dog forecast focused on the Bank of Japan's plan to stimulate inflation in the economy by convincing companies and individuals to spend and invest more money. 

Will the Bank of Japan's quest to create inflation succeed? 

Answer: No – correct 

An essential part of Japanese prime minister Shinzo Abe's 'three arrows' policies to stimulate the economy of the country was for the Bank of Japan to stimulate inflation to a 2% target. In 2018 it fell woefully short, just as we predicted it would. 

The desire to pursue inflation seems a little contradictory to traditional central bank goals, which typically focus on constraining price rises. But Japan, like Europe, has been in a very different situation for the past 10 years. The country's population is old and diminishing. It had 127.69 million people in 2008, but an estimated 126.99 million last year.

That has left a number of problems, not least the fact that elderly people tend to spend less, which hurts economic growth – and offers very little pressure on prices to rise. 

Just as consumer product prices rising too fast is a problem for an economy, the opposite is also true. If prices are static or falling, people have little incentive to try and make their money work harder. Instead, they can leave it in a bank account, knowing its value is not depreciating. That means fewer people seek to invest in the capital markets, and fewer spend their money on new goods and services. 

Abe prevailed upon his hand-picked BoJ governor to reverse this, and Haruhiko Kuroda did his best. He set a 2% inflation target and initiated a series of monetary stimulus measures, including setting up an array of exchange-traded funds (ETFs) that were supported almost entirely by the BoJ. The central bank accounted for an estimated 60% of Japan's ETF market in 2018, in an effort to prop up share values. Meanwhile, the BoJ set a zero-yield target for the 10-year Japan government bond, to encourage investors to put their money elsewhere. 

But even these efforts failed to overcome the sheer inertia of the world's third-largest economy growing at a meagre rate. According to data from the Ministry of Internal Affairs and Communications, Japan's monthly consumer price index inflation hit a high of 1.5% in February 2018 but thereafter tended to sit between 0.7% and 1.2%. At the same time, the country's economy was sluggish; indeed, it contracted by 2.5% during the third quarter of 2018.

That's assuming Japan's economic statistics are even accurate. On January 27, a data scandal centred on the government's data collection emerged. The Ministry of Labor was discovered to have collected economic data from just one-third of companies with over 500 employees for its Monthly Labor Survey between 2004 and 2017 when it was meant to have done so from all such firms. That's a problem for the BoJ, which uses the survey to calculate Japan's output gap, the main inflationary pressure in the economy. 

The revelation of the data shortfall prompted a broader investigation into Japan's 56 key economic data indicators, which revealed that 40% had inaccuracies. That raised more questions and prompted the government to revise down wage growth, a key part of Tokyo's inflationary efforts, for the first 11 months of 2018. Under the new statistics, Japan's average monthly wages grew by 2% or more for just one month (June) during that period, versus three months under the original government figures.

Judged against its self-imposed 2% target, the BoJ's efforts to boost inflation failed. And it's highly likely that its efforts fell even shorter than initially admitted. 

Previous Year of the Dog outlook reflections: 

Are European and UK stocks a good bet in 2018? 

Will the US Treasury yield curve invert?

Will Donald Trump still be president at the end of 2018?

What will be the best performing mainstream asset class, on a risk-adjusted basis?