parity–almost

Two days ago the Japanese yen reached a low where US$1 could buy ¥99 in the foreign exchange markets.  That’s extremely close to parity between the US penny and the yen.

What makes this level shocking is that last September, one greenback would only get you ¥77.  So the exchange value of the yen has dropped against the US$ by 22%+ in a little over half a year.  Stuff like this doesn’t usually happen with the national currencies of large developed world economies.

On the other hand, there aren’t normal times in the Land of Wa.

Japan’s problem

Japan has been struggling economically for almost a quarter century, plagued by a toxic combination of next to zero real economic growth + Deflation.  A falling price level means takes more of your income to repay debt, so no one borrows.  Things will always be cheaper tomorrow, so everyone postpones spending.

This stagnation is not an accidental occurrence, as I see it.  It’s the result of deliberate policy decisions by Tokyo aimed at preserving the social and cultural milieu of the 1970s-1980s–as well as the power of the aging and hidebound executives/bureaucrats/ politicians who came to power in that era.

How so?      The Japanese workforce is shrinking as the population ages, but immigration to replace those workers is not allowed.  Moribund companies are not permitted to die.  Instead, they’re kept alive by financial infusions from suppliers, customers and local financial institutions.  Nor are such firms encouraged to streamline or refocus so they can make money again.  Quite the opposite.  The government even protects inept or indifferent managements from any shareholder attempts to compel them to do so.  In many cases–the auto companies are one shining exception–zombie-like firms destroy the profitability of entire industries.

the inflation “solution”

Faced with severe voter discontent, the recently-elected new government has decided to “cure” the economic malaise by increasing the money supply until doing so creates inflation.  That’s the main economic plank the Liberal Democratic Party ran on, so arguably the ballot box shows the measure has popular approval.  Unfortunately for Japanese citizens, however,…

…there’s little reason to think that this will do lasting good

Textbook theory says an acceleration in money growth will lower interest rates and weaken the currency.  That gives the economy a temporary boost, which will gradually subside–leaving the country with the same real growth rate as before but with higher inflation.

A whiff of inflation is nothing too horrible in Japan’s case, since the country is suffering the ills of deflation–except for the risk that domestic interest rates will rise.  That could make it far more difficult for the government to finance the country’s huge debt burden.

In some ways, we’re in uncharted waters here, however.  Textbook theory is formulated from general economic principles buttressed by observations from practical experience.  Most of that experience comes either from small economies or from a much simpler pre-globalization (no BRICs) world, however.

So far, the announcement of Tokyo’s intention to create inflation has weakened the yen by a (to me) startling 22.5%.  That represents an extraordinary loss in national wealth.  It also means that dollar-denominated items–like food, clothing, fuel–that Japanese consumers buy on a regular basis now cost almost 30% more in yen than they did six months ago.  Yes, this is inflation, but not the healthy kind–wage increases driven by rising industrial productivity;  rather, this is a substantial fall in the Japanese standard of living.

Will the loosening of money policy lead to improvement in profits for Japanese industry?  In the case of commodity-like machinery output, the short-term answer is “Yes.”  Both the EU and the US have recently expressed strong concern that Japan is attempting to export its industrial woes through hostile currency devaluation.  This means that basic industry in both areas is already being hurt by Japan’s move.

On the other hand, will you now pick a Sharp TV over a Samsung, or a Sony smartphone over an iPhone/Galaxy S4 just because the price of the former has gone down a bit?  How many more boomboxes or Walkmen will you buy?

Perhaps most distressingly, for much of Japanese industry a lower currency will only make it easier to ignore their lack of innovation and their weak general management for a while longer.

The damage done to Japanese consumers is real and it’s today.  An industrial renaissance due to looser money is unlikely, in my view, while the government defends the status quo.  As the White Queen in Through the Looking Glass said, it’s “jam tomorrow.”