October & November 2024 Merger Monthly: "Suspended Japan" will be blown away by market revolt or Trump tariff shock

 

October & November 2024 Merger Monthly: "Suspended Japan" will be blown away by market revolt or Trump tariff shock

 

Tuesday, November 12, 2024

Shocking Trump landslide victory

 

Although it is regrettable that the heretic Trump, who may disregard free democracy and market capitalism, will return to the next US presidency, it was by no means unexpected.

 

However, what was quite surprising was the landslide victory of President Trump and the Republican Party he leads, which painted the US House and Senate red with Republican colors, and the US political situation is becoming such that it may give the heretic President Trump a free hand to return to power.

 

Until now, the United States has been respected as a mirror of the democratic world, but it may be undeniable that there is a danger that it will fall from democracy to authoritarianism or totalitarianism like Russia and China in the next four years. In any case, it is concerned that uncertainty will become increasingly serious not only in the United States but also around the world.

 

Contrary to the opinion polls which predicted a close race beforehand, why was it possible for Trump to win by such a shockingly large margin?

 

The US economy continues to enjoy a boom and high employment (low unemployment rate), but on the other hand, the price level continues to remain high, which is a crisis in living standards, and on the other hand, the soaring house prices have made it increasingly difficult for ordinary households to afford their own home. Although it may be presumptuous, these were almost exactly as the author predicted.

 

According to PBS News immediately after the presidential election, about 70% of the US electorate believe that the current economic situation is worse than it was four years ago, and it seemed as if the so-called American Dream of the past was now crumbling.

 

In addition, the dollar continued to rise against the backdrop of high US interest rates, and the slump in manufacturing (declining export price competitiveness) in the decaying US Midwest (Rust Belt) may have been the final blow to Trump's election, as workers and entrepreneurs in the battleground states sought change from the dissatisfied status quo. In the end, it is worth noting that the Republican president-elect Trump won in all of the battleground states.

 

Thus, it is clear that high prices and a strong currency were behind the return of the heretic Trump. Of course, other social issues such as racial division and immigration issues were also factors, but there is no doubt that this is simply a repetition of history in which economic issues ultimately matter in American politics.

 

However, when it comes to the future of the United States, it is difficult to say whether the return of the heretic President Trump, who won a landslide victory, will be able to restore the greatness of the United States like MAGA after January 2025.

 

For example, the US economy may accelerate inflation in the future due to Trump's promise to significantly raise import tariffs. As many American Nobel Prize winners in economics have pointed out the contradictions in Trump's promises and severely criticized Trump's economic policies before the presidential election.

 

In addition, if the US dollar continues to appreciate further, Trump may not hesitate to intervene in the currency by devaluing the US dollar in order to strengthen the international price competitiveness of US manufacturing. A trade war centered on tariffs could easily turn into a currency war.

 

In any case, shouldn't we consider that the biggest contributor to Trump's return to power was not only Biden's mismanagement, but also Fed Powell? This is because, in particular, the Fed failed to quickly and accurately recognize the acceleration of US inflation in 2021, and at one point allowed a 9% year-on-year inflation rate, resulting in price stability being behind the curve.

 

However, on the other hand, after that, in September 2024, with the US economy barely showing any signs of recession, it decided to significantly cut interest rates by 0.5%, further amplifying asset bubbles such as stocks and housing prices even as signs of a re-accelerating inflation were already visible. Shouldn't we also consider the immaturity of Fed Powell's monetary policy, which cannot help but be seen as belonging to the bubble cleanup faction, to have become an "accomplice" in Trump's return to power?

 

 

Who is Fed Powell's additional rate cut for?

 

At the FOMC meeting on November 7, when the results of the November 5 US presidential election had already been decided, Fed Powell moved to further cut interest rates by 0.25%, as expected by the market.

 

However, there is a sense of incongruity in the monetary policy of Fed Powell, who lowered the US nominal policy interest rate to 4.75% (although it is not comparable to the Bank of Japan's Ueda, who has still left the real policy interest rate in a deep negative zone).

 

For example, the latest SEP (Summary of Economic Outlook) in September, which moved to a significant rate cut of 0.5%, forecasted real GDP growth rate for 2024 at 2.0%, but the actual actual result for the most recent July-September 2024 period was 2.8%, significantly exceeding the FOMC forecast.

 

Next, regarding the unemployment rate, the latest October data recorded 4.1%, compared to the FOMC's 2024 forecast of 4.4%, and we cannot help but see that the US labor market is tighter.

 

Furthermore, core PCE inflation recorded 2.7% in the latest September data compared to the FOMC's 2024 forecast of 2.6%, so inflation is overshooting.

 

Only PCE headline inflation is only 2.1% in the latest September data compared to the FOMC's 2024 forecast of 2.3%. This is seen mainly as a reflection of low resource prices and a strong dollar.

 

In other words, of the four major economic indicators that the FOMC focuses on, the only one that can justify an additional rate cut after the September SEP is the last, PCE headline inflation.

 

As mentioned above, there is no doubt that in the 5 November US presidential election, the US electorate chose the return of the unorthodox President Trump and a major advance for the opposition Republican Party, mainly for economic reasons, namely the high price level in the US against the backdrop of the crisis of rising living costs.

 

For whom exactly is Fed President Powell continuing to lower interest rates?

 

In any case, regardless of the tariff hikes and tax cuts proposed by the next President Trump, US inflation will soon accelerate again, and it is inevitable that the US economy and its asset bubble will likely become uncontrollable.

 

Expectations that not only the unorthodox President-elect Trump, but also Chairman Powell, who leads the Fed, which is not an exaggeration to call the world's central bank, will lead not only the US economy and its financial markets, but also the global economy and international financial markets, on the path to price stability and sustainable economic growth may be greatly betrayed in the future.

 

 

Japan cannot change even if the LDP and Komeito lose their majority

 

On the other hand, almost as expected, the ruling coalition of the LDP and Komeito lost their majority for the first time in 15 years in the 10.27 Lower House election in Japan.

 

As a result of the Lower House election, the LDP's seats fell to 191, down 65 from the number they had before the election. In addition to two current cabinet ministers, many former cabinet ministers were defeated, and more than half of the candidates involved in the faction slush fund issue lost their seats. This shows the strong criticism of the public against the problem of "politics and money".

 

The LDP remains the largest party in the House of Representatives and aims to continue the coalition government together with Komeito, with whom it has once again reached a policy agreement, but the opposition parties hold a majority in the House of Representatives, and if a motion of no confidence in the cabinet is submitted, it may be passed, so there is no doubt that they will be forced to run a tough government.

 

The top priority that must be addressed is a fundamental reform of political funds. The Political Funds Control Law was revised in response to the slush fund issue, but many loopholes remain, and it must be revised again in the next extraordinary Diet session to make political funds more transparent.

 

Conclusions must be reached quickly on the opposition parties' requests to abolish corporate and group donations, quickly establish a third-party organization to monitor political funds, and disclose the use of the 1 million yen per month provided to Diet members for research, public relations, and accommodation expenses (formerly known as document, communication, and transportation accommodation expenses).

 

However, it is truly regrettable that the voter turnout for the October 27 House of Representatives election was 53.85% in single-seat constituencies, the third lowest since the war. As this historic low turnout clearly shows, we cannot help but see that the road to reforming Japan's political and economic system, which is rife with hereditary succession, privilege, and vested interests, and establishing a scenario for the revival of our country remains quite difficult.

 

In any case, as pointed out in the September Monthly, if Ishibanomics, which is nothing more than a fourth-rate version of Abenomics, continues, the Japanese economy and its financial markets may encounter the greatest crisis since the war against the backdrop of political uncertainty amid the quadruple economic difficulties of a declining birthrate, long-term stagnation of consumption, a weak currency, and rising inflation as exemplified by the Reiwa rice turmoil.

 

Even though the LDP and Komeito have lost their majority, a policy mix is ​​essential that combines a permanent reduction in the consumption tax rate to 5% to revive Japan, with a steady and gradual increase in the Bank of Japan's policy interest rate over the next two years or so into positive territory above the 2% inflation target, and the normalization of monetary policy.

 

Without this, far from being a virtuous cycle of wage increases and rising prices, which is nothing more than a "divine wind hope," we cannot help but fear that it will soon turn into a vicious cycle of mainstream Western economics, leading to an inflationary spiral.

 

In the end, under Ishibanomics, which seeks to continue stimulating aggregate demand indefinitely through fiscal and monetary policy, like running two engines at full throttle in an inflationary environment (even though a deflationary gap exists), the Japanese economy and its financial markets may find themselves plunged into an inflationary firestorm before the Japanese people themselves can draw up a convincing economic scenario for Japan's revival.

 

 

Bank of Japan Ueda is too timid

 

At the Bank of Japan Monetary Policy Meeting held on October 31, the market was expecting almost 100% to keep interest rates unchanged, but the author was expecting an additional rate hike as a "best case scenario."

 

In Japan, whether the economically "completely" tone-deaf Ishibanomics or the economically tone-deaf Noda, the leader of the Constitutional Democratic Party, becomes the prime minister of Japan, as Taro Yamamoto of the Reiwa Shinsengumi harshly criticized in the recent House of Representatives election, there will be a vicious cycle of currency depreciation and inflation, as the dollar-yen rate is starting to exceed 150 again amid a temporary period of lavish spending on fiscal policy. If this vicious cycle is not immediately broken, what is the purpose of the Bank of Japan's existence as the guardian of prices and currency?

 

In particular, the October Tokyo ward CPI, released on Friday, October 25th, just before the October 27th general election, recorded a price increase of +0.5% month-on-month (simple annual rate +6.0%) for almost all of the overall, core, and core-core. In particular, it was revealed that the price of rice, which is considered a staple food in Japan, was boiling at about 65% compared to the same month last year. It is no exaggeration to say that the Reiwa rice riots were in the midst of a major explosion of inflation.

 

In addition, the Monetary Policy Meeting held on October 31st was also the time when the quarterly outlook (aspirations) report was also released, and now that high inflation is clear, it was objectively necessary for the Bank of Japan to further raise interest rates at the end of October, even though it was right after the October 27th general election.

 

In any case, it is noteworthy that at the regular press conference after the Monetary Policy Meeting, Governor Ueda clearly indicated that at the next Monetary Policy Meeting on December 19th, he will publish a "multifaceted review of monetary policy," which he has promised since taking office in April 2023.

 

Although Ueda is completely behind the curve, he will likely have no choice but to raise interest rates further at the next Monetary Policy Meeting.

 

However, there is still more than a month until the next Monetary Policy Meeting. During this time, the Japanese economy and financial markets may encounter some kind of unexpected shock. Are we prepared to withstand them?

 

"The first to get going wins the race." The future of the Ueda Bank of Japan, which is not trying to act proactively rather than passively, is as precarious as Ishibanomics, which is tone-deaf to the economy, as the Reiwa Representative Yamamoto's style.

 

This is because, although it is true that domestic and international political situations are fluid, when we look specifically at the domestic political situation, all political parties are loudly advocating temporary, large-scale fiscal handouts. For example, Ishibanomics plans large-scale fiscal spending in the form of a supplementary budget totaling about 13 trillion yen, just over 2% of GDP.

 

Unlike a permanent reduction in the consumption tax, temporary fiscal handouts that have no permanence will only have a temporary, ephemeral effect on expanding the economy.

 

Moreover, while leader of the Democratic Party for the People, Tamaki, is eager to further expand the large-scale fiscal stimulus of Ishibanomics, he has clearly warned against the Bank of Japan raising interest rates further by next spring.

 

Thus, amid rising inflation, there are loud calls for temporary, large-scale fiscal support as a measure to combat prices, but no political party is accurately calling for the Bank of Japan to hurry up and normalize its monetary policy, which is necessary on a permanent basis to stabilize prices. It is truly regrettable that extremely irresponsible economic policy debates are rampant in both the ruling and opposition parties.

 

In light of this political situation, the Bank of Japan, which has allowed inflation to exceed the 2% price target for more than two and a half years, should not continue to be the government's watchdog forever, but should, as the guardian of Japan's prices and currency, immediately resume gradual additional rate hikes to bring the policy interest rate, which is only 0.25% in nominal terms, into positive real territory.

 

Now that Mr. Ishiba was re-elected as the next Prime Minister at the special Diet session on November 11, temporary lavish spending will continue in terms of fiscal policy, while the US long-term interest rates continue to rise against the backdrop of continued high growth in the US economy, the dollar-yen exchange rate has once again exceeded 150, raising concerns about a further depreciation of the Japanese yen.

 

If the Bank of Japan does not immediately put an end to this vicious cycle of inflation, which consists of a weak currency and rising domestic prices, there will be no point in its existence. One cannot help but be concerned that the future of the Bank of Japan led by Ueda, who is unwilling to read into the future and take proactive action, is just as precarious as Ishiba's economics, which can only be seen as completely ignorant of the economy.

 

Where is "Japan hanging in the air" headed?

 

Coincidentally, the Mainichi Shimbun published a very persuasive editorial in this morning's morning edition entitled "Second Ishiba Cabinet Launched: A shift to politics that emphasizes the Diet." In particular, there has been a lot of criticism of the "Diet hanging in the air."

 

However, this may be better seen as "Japan hanging in the air" rather than a "Diet hanging in the air."

 

Either way, the last chance for Japan to revive, which was finally born with the reversal of the ruling and opposition parties on October 27, may be lost forever if things continue as they are.

 

Is it possible that Japan will never be able to build a policy mix of fiscal and monetary policies that combines a permanent reduction in the consumption tax rate to 5% toward the abolition of the consumption tax and a gradual increase in the Bank of Japan's policy interest rate over a period of about two years toward a positive policy interest rate on a real basis that exceeds the 2% inflation target?

 

Unfortunately, if things continue as they are, Japan, hanging in the air, could be blown away in a storm like a kite with a broken string, by a financial market rebellion against drastic fiscal stimulus measures like those that led to the Truss administration in the UK in the fall of 2022, or by a Trump shock such as a large increase in US tariffs (including a large devaluation of the US dollar, like the Plaza Accord).

 

Tomo Nakamaru,

former World Bank economist