The G-20 meeting in Russia has come and gone and despite an apocalyptic message from the skies in the shape of comet it passed off without any relative incident.
It was unlikely that the G-20 meeting was going to end up in a brawl or slagging match, but the one point of contention to be discussed is the much hyped currency wars which appear to have been stepped up of late. There certainly is a bit of manipulation of currencies occurring at the moment but probably to the same level there always has only this time Japan has stepped up its efforts. This awoke investors and media alike from a relative 25-30 year slumber and the story that the Yen may retrace what is a 30 yr trend of appreciation was just too good not to splash everywhere and create a bit of noise in the market. Abenomics is the new buzzword but really Shinzo is merely following suit from the other central bankers around the world and stepping up its stimulus efforts or its un-official title ” Spend, spend, spend.”
Ultimately what Japan has done is target an inflation rate for its country of 2%. Japan is a country that has been mired with deflation or stagflation depending on which way you want to look at it since the Asian financial crisis back in the 80’s and while still being one the worlds top 5 biggest economies has not had much in the line of growth each year to shout about.
By targeting said inflation rate investors who have been long Japanese Yen for who knows how long know as its a safe place to put your money for so long ( not too volatile) some have headed for the exit door and some of the faster types of money have placed large bets for Yen to depreciate more well over the Y150 to the $1.
While I think this is entirely possible, and in one way I admire the Shinzo Abe and the Japanese for trying to kick start their economy after about 25 year hibernation ultimately I think its a flawed plan.
The main crux of the problem is that Japan has one of the if not the largest Debt- to -GDP ratios in the world, standing at over 212:1. To put that in context Greece and Ireland have circa 120-150:1 ratios after their bailouts. Japan is at least capable of printing its own currency to inflate the debt away.
Problem is two fold, the infamous Mrs. Watanbe who is the average Japanese housewife and famous for being relatively savvy but risk averse investor has most of her money in JGB which are Japanese government bonds. JGB’s yield is even milder than that in Germany in that the 10 year government bond currently yields approx 75bps and has not really been above 2% for a number of years.
Cost of Japanese debt has actually lowered from 8% to current prices all the while as their debt mountain has been steadily accumulating to the staggering amount it stands at today. That is almost acceptable in the funny world of finance as Japanese inflation was at zero or close to zero for so long , so Mrs Watanabe could still get a return on her investment that outpaced any minimal inflation, so in theory there was always a “natural” buyer for Japanese government debt, throw in steady encouragement from the Japanese government for its own people to buy its debt and hey presto you have yourself a self-sustaining debt market.
Problem is that the ageing population of Japan has led to less and less able bodied contributors to the ponzi-esque style. One dubious stat I heard recently says that the sale of adult diapers outpaced those of baby diapers in the country! I reckon the government have finally woken to this fact and wish to resolve the problem in some way before it gets any worse.
Two ways to resolve a large debt-to-GDP ratio are obvious you either pay down the debt or you increase the GDP side of the equation. So like I say I applaud their efforts to try and increase GDP, however they are attempting to do this by devaluing their currency to make their exports look more attractive to the global economy.
The more the Yen depreciates the more it will lead to inflation, the more inflation that occurs the more likely it is that Mrs Watanabe goes looking elsewhere for her return on investment so the logical thing to do as an individual is dump your holdings in bonds and invest elsewhere so that your return can increase to at least cover the effects of inflation on your savings. Problem for Japan is that if JGB’s go on sale then that in turn drives up the yield required on issuing new debt to meet responsibilities – think pension liabilities etc, exactly the same thing that caused so much carnage in Europe over the last two years in rising yields on sovereign debt and the pressure it puts on governments trying to finance this. This potentially could be a very dangerous situation as if the fear that was aroused in the theatre in Europe is still fresh in your mind then Japan will be the proverbial fat lady.
Also while it would be ridiculous of me to write off the Japanese economy you cant help but notice that they are attempting this perhaps a touch too late. Japan would be famous for its electronics and autos as its dominant export sectors. Its not difficult to see in your own living room that may once have been dominated by sony products, sharp or toshiba is now been replaced by Apple, LG or Samsung. Also while Toyota and Nissan are still one of the biggest car manufacturers in the world Volkswagen and some of the korean and US competitors have made good inroads to this thanks to savvy acquisitions brand management and technology improvements.
Also it may be difficult to improve your exports while you are involved in a spat with your neighbour and biggest customer in China over some irrelevant islands. This row did not get enough coverage in the West but was quite fiery and at one stage saw Chinese trashing Japanese cars in their streets. Now I am certainly not an expert on Japan- China relations so will leave it at that but still at worrying sign none the less.
Plenty will broke this development as a good time to buy the Nikkei and yes it probably will rise over the short to medium term but like a wild dog I would not turn my back on this market and get comfortable for one second. Keep it small and keep it flexible should be the strategy going forward.
It is in essence a financial experiment that has been played out for the last few years in other major economies- How do you stimulate growth in a debt ridden economy without completely wiping yourself out? To date there are certainly no clear cut answers and I think the US have had the best stab at it, and starting to see some results however tenuous, but the experiment is not over yet. Europe has done a good job at plugging the leaks but now need to rebuild the dam wall, Japan …..we will wait and see.
http://www.japantimes.co.jp/opinion/2013/02/18/commentary/third-branch-of-abenomics/#.USFbpqW-2So
VeryBearish 