In the 16 months since Japanese Prime Minister Shinzo Abe launched his bold plan to reflate Japan’s shrinking economy the yen has depreciated by 22% against the dollar, 28% against the euro and 24% against the renminbi. The hope was to stimulate trade and push the current account decisively into the black. Yet the reverse has occurred. Japan’s external position has worsened due to anemic export growth and a spiraling energy import bill: in January it recorded a record monthly trade deficit of ¥2.8trn $27.4bn. Having eked out a 0.7% current account surplus in 2013, Japan may this year swing into deficit for the first time since 1980. So why is the medicine not working?

via Guest Post: Japan’s Self-Defeating Mercantilism | Zero Hedge.

It’s a long article, well worth reading. Here I’ve selected excerpts and commented on them.

First, the title is tautologous: mercantilist policies have always been self-defeating for the nation as a whole in the long run. They are designed to bolster a particular group of people or section of the economy, at the expense of the individual and the consumer. Murray Rothbard put it this way:

In the days of Adam Smith and the classical economists, mercantilism was properly regarded as a blend of economic fallacy and state creation of special privilege….

Mercantilism, which reached its height in the Europe of the 17th and 18th centuries, was a system of statism which employed economic fallacy to build up a structure of imperial state power, as well as special subsidy and monopolistic privilege to individuals or groups favored by the state. Thus, mercantilism held that exports should be encouraged by the government and imports discouraged. Economically, this seems to be a tissue of fallacy; for what is the point of exports if not to purchase imports, and what is the point of piling up monetary bullion if the bullion is not used to purchase goods?

… Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.… But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.

“Mercantilism: A Lesson for Our Times?”, Murray Rothbard, writing in the Freeman, 1963. (See also the Wikipedia for Schools article on Mercantilism.)

But it’s not working! In 2013, Japan recorded a record annual trade deficit of 11.47 TRILLION yen (up from 6.94 trillion in 2012; that’s an increase of nearly 100%!). Rising costs for imports outstripped growth in exports.

Recall that Mr. Abe’s policy was to weaken the yen in order to boost exports. Trouble is, Japan is a resource-poor nation, something that all Japanese schoolchildren know. Many products manufactured in Japan require raw materials which must be imported. Thanks to Mr. Abe’s “weak yen” policy, those imports cost Japanese manufacturers and importers more. In addition, there were the unexpectedly large amounts of LNG which were required to power Japan’s industry to replace the lost wattage of the 54 nuclear power stations which were taken offline after the 2011 earthquake-tsunami-Fukushima disaster.

Brilliant, Mr. Abe!

Back to the article. Here’s the theory:

Consumers are immediately hit with an implicit “tax” as imported goods cost more, while export-oriented firms get an effective subsidy.

Yes, exporters get a boost, but against this, in Japan’s case, must be offset the rising costs of energy and of importing raw materials.

In the capital markets, the effect is to lower the value of domestic bonds in foreign currency terms, with the result that yields rise. This means that the cost to the government of financing its deficit rises, forcing a reduction in government spending. As a result of these effects, resources are shifted from the household and government sectors and into the corporate sector. The effect of this resource reallocation should be to boost productivity, which in turn initiates a virtuous circle of rising incomes and ultimately higher consumption.

Needless to say (for those living in Japan), neither has happened. Why not?

in addition to devaluing, it is also engaging in massive quantitative easing. This keeps bond yields low, enabling the government to keep financing its deficit at low cost. There is thus no incentive for the government to cut spending— and in fact the consumption tax hike will be offset by even more spending. Furthermore, low bond yields suppress the financial income of household savers.

Great. So in addition to having to pay more for imported goods,  and for electricity (both for their own household use and for that of the manufacturing industries), consumers are unable to gain any real benefits from their savings, because interest rates are so low.

Question: if savings are discouraged, how will the capital needed for future investment be accumulated?

The end result of all this is that the government bears none of the burden of the adjustment and the household sector bears all of it, through higher import costs and lower financial income. With the household sector’s spending power thus crimped, companies have no incentive to invest in domestically-focused production. Instead, all their investment will be geared toward exports—mercantilism on steroids.

With the predictable result that the consumer gets it in the shorts. Of course, exporters, to the extent that they are individuals, are also consumers.

Since all the leading economies favor policies that support production over consumption, the world is getting more goods than it can absorb. The result is ongoing price declines, which have the effect of deferring the ultimate global recovery.

The problem is not falling prices per se (see this brilliant article debunking the “deflation is evil” myth); the problem is subsidized production, because this distorts price signals and prevents resources from being re-allocated in a timely fashion.

What this means is that Japan’s ultra-mercantilism is self defeating. In a global environment of weak demand and disinflation any volume increase in its exports will have to be paid for through price reductions…

Japan’s most likely path is that the yen keeps falling, the BoJ keeps printing money, and the dollar value of exports stagnates as devaluation and price cuts offset any volume increases. And so, paradoxically, the current account will continue to deteriorate into permanent deficit, despite ultra-mercantilism. At this point the game will have changed in Japan and Abenomics will have manifestly failed to deliver on its stated objectives.

The sad part is that this outcome is all so predictable. We don’t actually have to try the experiment to know that it is highly likely to fail, meaning it won’t result in increased productivity, economic growth, consumption or savings.

How will Japan’s voters react when they see that Abenomics has failed? Is there anyone offering any alternative to mercantilist policies?