Japan seems to have joined the bandwagon. Last week, Bank of Japan (BOJ) announced a major quantitative easing (QE) program in an effort to revive the economy out of deflationary pressure that lasted more than a decade. The credit goes to Shinzo Abe – the new prime minister of Japan – and certainly his so-called Abenomics.
BOJ has decided to purchase ¥7 trillion ($71 billion) of long-term government bonds, a drastic move that will double Japan’s monetary base (cash circulating in the economy plus commercial banks’ reserves with the central bank) to ¥270 trillion ($2.7 trillion) from ¥135 trillion ($1.4 trillion) within two years.
With ample cash being injected into the economy, consumer spending will increase pushing price and wage levels upwards. Based on this radical Abenomics principle, BOJ’s newly-appointed governor Haruhiko Kuroda intends to achieve an inflation rate of 2% per annum within 2 years.
Japanese yen has already been falling due to the government’s devaluation. Since last June, the yen has dipped by more than 20% against the U.S. dollar. The falling yen has been helping the Japanese economy very well in boosting exports.
Exports in Japan went up 6.4% on a year-on-year basis in January for the first time in eight months. Exports to the U.S. grew 10.9%, including a 10.5% and 29.9% rise in exports of automobile and auto parts, respectively in the same month. Higher exports mean lower trade deficit in medium-to-long term as well as higher GDP.
The recent QE measure by the BOJ delivered another blow to the falling yen. Since the announcement on Apr 4, yen depreciated sharply by 5.6% against the dollar, ending its short-term gain following the Cyprus crisis. It also led the Nikkei index go up by 5.1% for the week, the second strongest since November last year. Kudos to Abe!
The Pain of U.S. Automakers
A falling yen certainly boosted the confidence of the Japanese automakers operating in the U.S. and, on the other hand, inflicted pain to the U.S. automakers. Toyota Motor Corp. (TM - Analyst Report), being the largest among the Japanese auto manufacturers, is expected to be the biggest gainer from the currency tailwind.
According to a Deutsche Bank report, Toyota exports more than 2 million vehicles from Japan and about 27% of the vehicles sold by it in the U.S. are imported compared with 10% by Honda Motor Co. (HMC - Analyst Report). The report also revealed that 15%–35% of the parts in models built by Toyota’s North American facilities are imported from Japan. As a result, Toyota is believed to be very well positioned to take advantage of the falling yen compared to other automakers in its home country.
Last year, Toyota recaptured the sales crown from General Motors (GM - Analyst Report) by selling 9.75 million vehicles globally, which exceeded GM’s sales of 9.29 million vehicles. The falling yen could further help the company in achieving its goal of selling 10 million cars and trucks globally by 2015.
In the third quarter of the fiscal year ended Dec 31, 2012, Toyota saw its operating income dip 16.7% to ¥124.76 billion ($1.54 billion). Further, the company continues to struggle with a series of safety recalls, costing it millions of dollars for fines and penalties.
Nevertheless, the automaker expects significantly higher operating income of ¥1.15 trillion (up 223.4% from fiscal 2012) and net income of ¥860.0 billion (up 203.3% from fiscal 2012) for fiscal 2013 ended Mar 31.
Honda also expects operating profit to improve 124.8% to ¥520.0 billion and net profit to go up by 75.0% to ¥370.0 billion in fiscal 2013. All these undoubtedly reflect benefits from the depreciating yen.
The U.S. automakers, especially the Detroit Big Three including GM, Ford Motor Co. (F - Analyst Report) and Chrysler, are highly concerned about how falling yen would provide a competitive edge to the Japanese automakers in terms of pricing. They have already tasted the bitterness seeking bankruptcies or undergoing aggressive restructuring during the global economic crisis in 2009 in order to become afloat in a market dominated by the Japanese automakers.
The U.S. automakers are afraid that Japanese automakers might use the depreciating yen as a strong weapon to beat them, unleashing many growth-oriented strategies and launching new models using their inflated profits. This in turn may compel the U.S. automakers to engage in price wars, eroding their margins over time.
What Fed has to Say?
The U.S. Federal Reserve has apparently welcomed Abe’s policies for choosing the path paved by them. Fed’s Chairman Ben S. Bernanke already considered Abe’s currency policies as “mutually beneficial,” while many political activists are able to see its potential threat and asked for corrective action. Bernanke believes that Abe’s policies are mainly intended in mending the Japanese economy rather than hurting the interest of major economies around the world.
How Sustainable is the Effect of Favorable Yen?
Firstly, Abe’s policies could significantly offend certain groups of the world economy due to its resultant impact of a currency war. They could seriously undermine the decisions taken by G7 finance ministers and central bank governors at their February meeting against currency devaluation as a measure to revive the economy. They have clearly mentioned that volatile and disorder movements in exchange rates could have adverse impact on economic and financial stability.
Given the ailing conditions of the global economy at present, it is quite possible that many countries would seek currency devaluation in order to secure a competitive advantage, resulting in nothing but a zero-sum game. Apart from the currency war, Abe’s policies could also endanger the stability of the international monetary system and the very existence of the global capitalism.
Secondly, currency could not be the sole weapon in winning market share and boosting profits. It is true that Japanese automakers gain competitive advantage in the U.S. market due to the currency effect but that doesn’t make them invincible in the global market.
Demand for Japanese automotive brands in the world’s biggest market China has already shattered due to the political conflict between Beijing and Tokyo over disputed islands in the East China Sea. According to the China Association of Automobile Manufacturers (CAAM), sales of Japanese passenger cars dipped 16% year-over-year in the first quarter of the year.
In contrast, emerging markets such as Brazil, China and India are gradually becoming the biggest strength of Detroit automakers. Both Ford and General Motors have embarked on a major expansion plan in these markets that include investment in new facilities and rolling out new models. Ford expects Asia to account for 70% of its global growth in this decade, mostly from China and India.
On the other hand, GM plans to upgrade 70% of its global lineups by the end of this year and invest $8 billion annually in new vehicle development. The automaker plans to pump in $1.5 billion in its North American facilities in 2013 as part of its annual investment plan for new vehicle development. The company expects to boost profit margins in the region from the current 8% to 10% in the next three to four years.