Once More On The Yen ...

Here's another guest post from Danish Blogger Claus Vistesen:


Once More On The Yen ... Talk Is In Fact Cheap

Some days ago I reported on how policy makers at the G8 summit in Skt Petersbourg were trying to talk up Yen in the midst of the recent weakening of the currency relative to the Dollar and Euro. The Japanese Finance Minister called the recent drop in the Yen a 'little rough' whereas others talked about how the value of the Yen simply did not reflect the fundamentals of the Japanese economy which after all is in the midst of a sustainable recovery. I obviously diagree here and I believe that the Yen's recent tumbling is very much aligned with the fundamentals of the Japanese economy; that is an economy which is having mighty difficulty escaping deflation, particularly after the CPI index was revised in August, and as such the BOJ is not going to embark on a hike any time soon.

Should we see what the markets have to say about the Yen then despite all the well thought comments from the G8 summit ...

(From Bloomberg - bold parts are my emphasis)

'The yen may fall to a 20-year low as individual investors in Japan join speculators on the Chicago Mercantile Exchange in selling the currency.

Measured against currencies of Japan's largest trading partners, the yen is approaching its lowest value since 1985, an index prepared by the nation's central bank shows. Japanese investors last month bought more overseas bonds than ever before. Traders on the Chicago futures exchange have a $9.74 billion wager the yen will decline.

The currency has fallen 4.3 percent against the dollar in the past four months as a rebound in the economy faltered, suggesting the Bank of Japan won't raise interest rates again this year from 0.25 percent. The prospect that rates will remain among the lowest in the world has prompted Japanese to invest more of their $6.55 trillion in currency and deposits outside of the country.

``We could see more massive outflows,'' said Lara Rhame, a senior currency strategist at Credit Suisse Group in New York. ``It's the yield story that's driving Japanese investors abroad.''

The yen will weaken to 118 against the dollar in three months and 120 in a year, Credit Suisse predicts. Last week the yen gained 0.9 percent against the dollar to finish at 116.56 and declined compared with the euro to 149.

(...)

Back to the good-old yen carry trade ...

'U.S. and European money managers also are putting pressure on the yen by borrowing the currency at low rates and then investing in countries with higher yields, such as New Zealand and Iceland. The prospect the so-called carry trade will weaken the yen has encouraged others to bet against the currency.

Speculative short positions, or bets that the yen will fall, outnumbered long positions by 90,804 contracts on Sept. 19, up from 69,498 two weeks earlier, CME futures trading data show. Futures contracts are agreements to buy or sell a security at a specific date and price. Each contract is for 12.5 million yen.'

There is plenty more interesting points in the Bloomberg piece linked above and it is definitely worth, at least, a quick glance. As for my discourse on this it should come as little surprise for regular that this has a lot to do with the demographics of Japan. Actually demographics can explain much of what has happened in Japan the last decade. However, it seemed as if the end of ZIRP (Zero-Interest-Rate-Policy) a year ago by the BOJ, at least for a time, made people exactly forget about the fundamentals of the Japanese economy; that is that they did not change just because the BOJ shifted course. Let me be as clear as I can possibly be; Japan is not back amongst the leaders in the global economy in the sense that the country has finally escaped deflation (deflation is still a distinct possibillity here) and Japan is not going to experience any sustainable recovery based on a surge in domestic demand as many pundits predict. Given the current population dynamics of Japan the country's relative clout in the global economy will decline and obviously relative is important here since Japan still is one of the world's biggest economies but, I am sad to say, decline it will.

Japan's Trade Surplus

The recent drop in oil prices and the low value of the Yen seem to be sending Japan's trade balance once more spiralling into surplus:

Japan’s trade surplus rose nearly 100 per cent in August, showing that net exports were still contributing to overall economic growth and that the effects of high oil prices were slowly waning.

Although the leap was smaller than expected, economists said the numbers showed that exports to the US, China and Europe continued to expand. Because exporters tend to take a summer break in August, the trade surplus is generally small, making big changes in percentage terms quite common.

Japan, At Last Some Sense

This article about the extent to which the Japanese treasury is dependent on company profits for income is interesting, but beyond that I'm not sure how to interpret the fact since I am not sufficiently knowledgeable about the Japanese fiscal system.

However, a number of points do stand out. Corporate profits now fund the revenue:

Japanese corporate profit tax receipts are poised to overtake personal income tax contributions for the first time in 18 years, a shift that could influence debate among contenders vying to succeed prime minister Junichiro Koizumi.

Wages seem to be flat:

The figures highlight the strong return to profitability of Japanese companies, which have retained most of their gains without passing them on to workers in the form of higher wages. Although the labour market has become tight - with more jobs than job-seekers - wages have hardly risen, although bonuses have improved.

Consumption taxes are soon set to rise:

The finance ministry wants to rebalance the tax system largely by increasing consumption taxes. A central plank in the prime ministerial campaign platform of Sadakazu Tanigaki, finance minister, is a doubling of the sales tax to 10 per cent.

Although not everyone agrees:

Shinzo Abe, who is likely to win the leadership contest, is influenced by policymakers who argue that raising taxes could damage consumption and harm overall economic activity. His policy is to cut spending and try to increase the government’s tax take through promoting growth.

But funding through growth is just what has been tried and failed, that's why the debt is where it is. This view rings hollow.

Most Lopsided Economy in the G7

And then along comes Andrew Smithers:

Andrew Smithers, an economist at London-based Smithers & Co, has said in a recent report that the swing in corporate profits might need to be reversed in the interests of domestic consumption. He argues that Japan is the most lopsided of the G5 economies - the US, UK, Japan, France and Germany - with the lowest consumption and highest investment ratios; the largest current account surplus and budget deficit; the worst demographics and the lowest interest rates.

“These oddities are almost invariably ignored,” he says. “They illustrate how far the economy is from any likely equilibrium and this conflicts with the conventional wisdom which holds that Japan has corrected the past distortions of its economy and is now set on a path of balanced growth.”

Moreover the household savings rate has been falling steadily: from nearly 12 per cent of GDP in 1997 to just over 2 per cent last year. This is also perplexing, does this mean that, following the Life Cycle Theory people do finally get to dis-save in the end. I have long entertained doubts about this, but household saving in Japan is definitely something to watch. But what this seems to suggest is that after the reforms the Japanese are not only not spending, they aren't even managing to save like they used to.

Crunchtime in Japan?

Here's another guest post from Danish Blogger Claus Vistesen:

Crunchtime in Japan?

Well I have pointed to this several times and most recently as the CPI index was revised bringing Japan dangerously close to the 0% inflation mark amidst talks of business cycles topping and whether the BOJ should indeed raise rates any further. This is of course very unlikely now and the future road for Japan might very well be another period of deflation or at least no-one can rule out this possibility at the current juncture I think.

Now, a revision of the statistics might not be important in itself but let us take a quote from and article in The Economist I used as a source in one of my posts linked above.

'This reshuffling of the statistician's shopping basket has rewritten recent history (see chart). Japan, it now seems, did not escape deflation definitively until July, when the core annual inflation rate reached 0.2% for only the second month in a row. As Richard Jerram, of Macquarie Research in Tokyo, puts it “price pressures today are where the BoJ thought they were six months ago.”'

So Japan is not quite out of the deflation spiral it seems or at least trying hard to get off the mark. On top of this the US is slowing which will be sure to dent Japanese exports. China will probably be able to do some heavy lifting here for a while but the main point here is that Japan lacks the domestic demand structure to carry through a sustainable recovery. Why? well a brief look at the country's demographics is of course quite illuminating here as I have argued several times. Another blogger worth mentioning here is Edward Hugh at Bonobo Land who actually was the one who initially steered me into seing Japan the way I do today ... more or less that is. His latest report on Japan is also very telling of things to come ...

Machine orders in Japan is falling rapidly ...

(quote Bloomberg)

'Japan's machine orders fell the most in almost 20 years, dashing expectations that the central bank will raise interest rates before the end of the year.

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. Orders from semiconductor, steel and mobile-phone businesses paced the drop.'

(Quote Edward)

This is what we could call a second stage event, and now has all the hallmarks of a classic domino chain, although it still isn't clear how far it will reach (all the way to Shanghai??). I am not at all convinced that investment in the US will take up the slack given what we know about fixed capital investment in China, and given the way capacity in things like machinery and equipment has just been ramped up so much in Germany and Japan. As we can see, in Japan it is fixed capital investment that is being hit first.

So watch out everyone, 2007 could be a very complicated year.

Update on Monday, September 11, 2006 at 10:25PM by CV

The Yen/Euro relationship also tells an important part of the story here ...

(quote Bloomberg - bold parts are my emphasis)

'The yen had its biggest drop against the euro since April on speculation the Bank of Japan will lag behind the European Central Bank in raising interest rates this year.

Japan's currency also slid from a one-month high after a government report showed machinery orders fell the most in almost 20 years in July. ECB Chief Economist Juergen Stark was reported today as saying inflation in the 12 nations sharing the euro will stay above target this year and next.

The drop in machinery orders `` confirmed the market's expectation that the Bank of Japan is likely to raise rates at a very slow pace this year,'' said Kamal Sharma, a currency strategist at Bank of America Corp. in London. ``The yen is likely to remain under pressure.''

(...)

``We'll see widening interest-rate differentials from here,'' said Benedikt Germanier, a currency strategist in Zurich at UBS AG. ``The key for euro-yen are the machinery order numbers which came in weaker.''

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. The median forecast of 30 economists surveyed by Bloomberg News was for a 5.4 percent decline.'