Japan Prepares for President Trump – Part 2

Trade and Tariff Concerns

‍

Japan's trade exposure to the US and China is substantial, with aggregate exports to both countries reaching approximately USD 400 billion each over the past three years (first graph). Ongoing tariff discussions are a major focus in Japan. In October, Treasury Secretary nominee Scott Bessent noted in interviews that “Trump is a free trader” and suggested Trump generally aims to “escalate to de-escalate” tensions. “My goal for his administration would be to save international trade” (Bessent).

However, in November, Bessent made a more forceful case for tariffs to Fox News: “Used strategically, tariffs can increase revenue to the Treasury, encourage businesses to restore production and reduce our reliance on industrial production from strategic rivals.”

On November 25, Trump announced plans for a 25% tariff on Mexico (and Canada) and an additional 10% on China. This is particularly relevant for Japan, as several Japanese automakers have production facilities in Mexico to export vehicles to the US. In 2023, production percentages for Japanese brands in Mexico were significant: 2% for Toyota, 8% for Nissan, 3% for Honda, and 9% for Mazda (Nikkei News). Of course, many US and European automakers also rely on Mexican production. Thus tariffs on Mexico, the seventh-largest auto manufacturer globally (next graph), could lead to a general shift in auto production back to the US, a phenomenon referred to as “tariff jumping.” Additionally, reports say there has been a general surge in all Chinese exports to the US to get ahead of any increased tariffs.

Shifts in EV Policy

Trump's stance on electric vehicles (EVs) has evolved. Initially critical of Biden’s EV policies, he has softened his position after gaining Musk’s support, declaring himself a “big fan of electric cars.” However, analysts predict that Trump may eliminate Biden-era tax incentives and anti-pollution regulations while maintaining 100% tariffs on Chinese EV imports, potentially benefiting hybrid vehicles, including those produced by the Japanese.

Economic Outlook

The US GDP outlook remains uncertain. Following the election, a rally in US stocks and rising yields reflected expectations of higher growth and inflation driven by Trump’s proposed policies on tariffs, deregulation, tax cuts and immigration. Nonetheless, there are concerns that the US economy may slow down in the future, with one forecast from the Japan External Trade Organization suggesting that Trump’s tariffs could reduce US GDP growth by 1.1% by 2027.

According to the December Tankan survey, Japanese corporate sentiment remains strong, with many believing that “Trump is good for business.” Wage growth in Japan is supporting consumption, and pricing power  - even for small enterprises - remains close to 40-year highs, bolstering corporate profits (next graph). Through the evolving market for single stock options, investors can gain leveraged exposure to Japan.

Investor Perspectives

For Japanese bond investors, the costs of hedging the currency risk involved with US bonds remains high due to a significant US-Japan interest rate differential. Trump’s policies are generally viewed as inflationary, which could keep this differential wide and the yen weak as the next graph shows. Some investors subscribe to the “Dollar Smile Theory,” which posits that the dollar will perform well in both risk-off and risk-on environments. However, there are also concerns that Trump’s policies could eventually lead to a stronger yen as secondary effects take hold. For example, import inflation and a mass deportation of immigrants could ultimately hurt consumption, while more oil production could cause inflation to fall. These scenarios could tighten the US-Japan interest rate differential via lower US yields. And in the worst case, Trump could try to devalue the dollar as part of his trade policy.

Preparing for the New Energy Order

With Trump’s dismissal of climate change, US clean energy policies may diverge from those of Europe, complicating global cooperation. Expected changes in the US started a Nikkei News column titled, the “New Energy Order”, which reports on lessons learned from abroad.

In one lesson about “carbon leakage,” the articles note that some European heavy industries appear to be relocating to countries with less stringent environmental regulations. In another lesson about “senryaku-naki datsu tanso (nonstrategic decarbonization)”, the Nikkei notes that Europe’s embrace of EV’s probably caused domestic automakers to lose share to Chinese imports.

Finally, in a lesson about AI’s energy needs, the articles note that one Chat GPT response uses about 10 times the electricity of a Google search. To prepare for future energy needs, Microsoft made a deal to restart a nuclear power reactor on Three Mile Island, the site of America’s nuclear accident in 1979. Similarly, Google and Amazon are making investments in nuclear energy development as well. In a reminder for Japanese nuclear energy policymakers, the article noted, “Before Fukushima, Japan had 54 reactors humming, but after Fukushima only 14 were restarted”.

Aligning with Other Nations

The Trump presidency might lead to the US withdrawing from the Paris climate agreement, pushing Japan to strengthen ties with other nations, particularly in Europe. Recent agreements between Japan’s Prime Minister Ishiba and UK Prime Minister Starmer aim to enhance cooperation to combat protectionism. And international tax experts expect that cooperation on digital taxation – a proposed framework to tax big tech globally - may have to plow ahead without the US.

Highlighting Japan's Contributions

Japan is the largest foreign direct investment (FDI) contributor to the US, the second-largest contributor to US GDP after the UK, and the second-largest employer in the US [i]. Bessent’s “3-3-3” economic plan for the US [ii] was modeled after the Abenomics “three arrows” strategy for Japan. Japan hopes that these contributions will be recognized and valued by the Trump administration.

In conclusion, as Japan prepares for the Trump administration, it must navigate complex trade dynamics, evolving energy policies, and the impact of US economic strategies while emphasizing its contributions to the US economy.