quantitative easing in Japan
With all eyes on Greece, one of the less noticed developments in global securities markets is the recent decline of the ¥ versus the US$. As I’m writing this on Thursday morning, the ¥ has weakened from a high of ¥76 = US$1 reached on February 2nd to the current ¥80 = US$1.
This is not just the result of one of Japan’s periodic, ultimately fruitless, attempts to intervene in currency markets to temporarily weaken the ¥. Instead, it’s the currency markets reaction to what appears to me to be a substantial shift toward monetary easing by the Bank of Japan.
Why do so?
After over two decades of minimal economic growth and mild deflation, citizens’ tolerance for political and bureaucratic bungling of Japan’s economic policy seems to me to have finally been exhausted. Voters are deeply unhappy with the administration of the recently installed Democratic Party of Japan. But no one wants the Liberal Democrats back either. There’s serious discussion about forming a third political party–really radical thinking in a country where politics has been dominated by a single party, the LDP, for a half century.
There’s also been talk in the Diet of legislation that would take away from the Bank of Japan its Federal Reserve-like role in setting monetary policy. This threat appears to be what’s prompted the central bank to launch the new program of quantitative easing. The BoJ is basically saying that it will continue to inject money into the system in large amounts until inflation reappears. In other words, the new stance is the Fed’s approach, but on steroids.
In the near term, this policy will likely continue to weaken the ¥, removing one source of pressure on the profits of Japanese export-oriented companies. It’s already prompting investors in the Tokyo stock market to re-orient their portfolios toward export-oriented stocks. I don’t think this policy move, by itself, has the slightest chance of removing Japan from the morass in which it has been trapped for many years, however. And substantial negative consequences may lie down the road.
As anyone who has read me on Japan before knows, I think the fundamental issue for that economy is the ground-level social decision made twenty years ago not to adapt to a changing world, but to preserve the traditional social order even if that meant slower economic growth. After all, the country did hide its banking problems for a decade. Despite a shrinking workforce, it doesn’t allow immigration. Its laws cement the management practices of twenty year ago–and most times the actual managers–in place and defends them from virtually all attempts at change. Iconoclasts risk social censure, or worse.
Sounds a lot like the Eurozone, doesn’t it–one currency, but keep the local power brokers in place?
Without substantial structural pro-growth reforms, what’s likely to happen?
For a while, nothing much. The character of the stock market will continue to change, as investors shift away from smaller, counter-culture secular growth stocks to larger, older exporters. But for foreign investors, a large part of any local currency gains will be erased by currency losses. So it will be even harder to make money in Tokyo than before.
The strategy, however, seems to me to be playing with longer-term fire. The central government has piled up a huge amount of debt, which it can continue to service both because interest rates are extremely low and because–lacking other investment alternatives–Japanese citizens continue to buy tons of government bonds. Reemergence of inflation will mean, at the very least, rising nominal interest rates, and therefore rising debt service for the government. In addition, in an all too rigid economy, inflation may spread relatively quickly and begin to have negative effects on the value of Japanese assets. If so, Japanese investors may shift their money away from government bonds and toward inflation-protection vehicles, like real assets or foreign securities. That might lead to further currency weakness and compound the government’s funding problem. So a sovereign debt crisis, while not imminent, may be ultimately waiting in the wings.
what I’m doing in response
I own two Japanese stocks, DeNA and Gree. I like them both, although each has taken its lumps as the market orients toward exporters. I’m certainly not going to add new money to Japan. And I’ve got to consider whether I lessen my exposure. If DeNA and Gree didn’t have substantial businesses outside their domestic market, I’d be doing that already.