I have been in the financial business since the early nineties and as long as I can remember, Japan has been in decline. So it’s natural to be skeptical of Abenomics and the ability of the country’s leadership to effectively deal with its economic malaise. However, the patient seems to be reviving, albeit slowly. The three prong strategy, aimed at dealing with Japan’s structural problems to allow the economy to function normally, has been partially implemented. Monetary and fiscal policy have tamed deflation and ignited the stock market, but is it just a sugar high? A consumption tax of ten percent or higher is cautiously being implemented in steps, to deal with Japan’s overwhelming sovereign debt. An intentionally weak yen has made Japanese exporters much more profitable. These measure have been the low-hanging-fruit, the easy stuff. Now Japan’s leadership have to take their game to the next level. That means dealing with the structural issues that have been dogging the Japanese economy for decades. I’m talking about labor market reform, immigration policy, women in the workforce, et cetera. There are entrenched interests lined up against these measures and implementing them will be difficult. If it was easy, it would have done already. It’s not easy.
But what does all of these portend for the future of the Yen? The Japanese central bank has been engineering a weak yen for months now. Today we are almost at a 110 handle against the USD. If you listen close enough, you can hear the wailing and gnashing of teeth in Japan at this level of weakness. Yes, exports have been stimulated; however, this has come at the expense of import costs. Japan doesn’t have a domestic hydrocarbon energy market. This has made fuel imports very expensive which is significantly hitting domestic spending. This is especially significant in light of the recent nuclear disaster. The Japanese economy shrank around six percent year-over-year in the second quarter of this year.
What could cause the Yen to turn around? Higher interest rates for one thing, could halt the currency’s slide. However, this does not look to be in the cards in the near future. It will be some time before the central bank will consider raising short term rates from essentially zero. Longer term rates are being impacted by the central banks intervention in the market through its quantitative easing program, or QE. It seems there is some debate as to whether this effort should continue. Inflation is looking to be around ½ of one percent. This is not significant but it is noteworthy as positive inflation is better than the deflation Japan has been experiencing.
The other variable which could impact the Yen’s value is central bank interference in the currency markets. Japan is not the export machine it used to be. Therefore, the weak currency will not have the long term effect on the Japanese economy that it might have thirty years ago. In fact, a case could be made that the Yen at 110 is doing more harm than good.
In the long-run, the real question that FX players need to ask is, can the government make the hard decisions to unleash the economic power of the Japanese nation? We have not seen this toughness in Japanese politicians for a long time now. Why should we expect to see it now? There are difficult reforms that need to be implemented. Many a golden ox will be gored. This is what will drive the long-term direction of the yen. I would suggest investors watch and wait. There will be plenty of time to get in if it looks as if Abe’s government can make the hard decisions and force change. Otherwise, the Japanese will continue their quest for the dustbin of history.
- Todd Wood is a former emerging market debt trader with 18 years of Wall Street and international experience. He is also an author of historical fiction thriller novels. His first of several books, Currency, deals with the consequences of overwhelming sovereign debt. He is a contributor to many media outlets and is a foreign correspondent for Newsmax TV. LToddWood.com