overnight: sharp drop in the yen, global stock market rally

what’s going on

A month or so ago–I don’t remember the exact timing–the Japanese central bank expressed concern that its weak yen policy was great for export-oriented companies but was hurting ordinary citizens, since food, fuel and other daily necessities are generally priced in dollars.  So these items cost a quarter or a third more today than they did before Abenomics kicked in.  The Bank of Japan intimated strongly that, because of the deterioration in citizens’ living standards, it was no longer interested in further yen weakness.

This morning in Tokyo the Bank reversed course and voted 5 – 4 to increase the amount of extra money it’s pumping into the economy, in what is now an all-out effort to create 2% inflation.

The yen has dropped by about 2.5% against the dollar, as I’m writing this just at the NY open.  The Japanese stock market rose by about 5% on the announcement.  Europe and US stock index futures are up as well.

my take

As I’ve written, probably too many times, I think Abenomics will end in tears.  Continuing currency weakness will just make the ultimate bad outcome worse.  That’s because I believe the root cause of Japan’s quarter-century economic malaise is that the country has chosen to defend its traditional way of life at the expense of economic progress.  One result has been to perpetuate a culture of covering up industrial/manufacturing mistakes.  Fukushima Daiichi is a terrible example; Takata airbags are the latest.  Impossible legal and cultural bars, many erected in the 1990s, still exist to removing from power people at the top of the pagoda, so to speak.

Continuing currency weakness will, in theory, buy more time for change to occur.  Admittedly, I’m no longer in close contact with the Japanese economy, but I don’t see any signs that effective change is happening.  Without it, the depreciation of the yen will mostly mean a massive loss of national wealth–and more time in power for incompetent industrialists.

(In my view, France and Italy have almost exactly the same issues.)

So, while the new tide of central bank money into the world will likely make markets move higher for a while, its main effect will probably be to smooth over economic bumps in the road for the US and China.  We should enjoy the ride.  But we’ve also got to think about how to defend ourselves from the ultimate negative consequences for Japan–and anyone who does business with/in the Land of Wa.




crunch time for Abenomics in Japan

The economic program of Prime Minister Shinzo Abe to revitalize a Japanese economy that has been dormant for a quarter century has three main points, or “arrows”:

–increased deficit spending by a national government already very deeply in debt,

–loose money policy to weaken the currency, making Japanese industry more competitive while supporting the dismantling of a raft of protective practices that have debilitated a once-powerful industrial base, and

–the corporate overhaul itself–the elimination of a nexus of laws and policies that have perpetuated now-outmoded industrial practices from the 1960s-1980s, and which have  also made it virtually impossible to replace the incompetent top managements that have run many Japanese companies into the ground.

Arrows #1 and #2 have been fired successfully.

To my mind, however, Abenomics has always been about the government’s ability to fire arrow #3.

That’s not going so well.  More than that, almost thirty years of watching the Japanese economy and Japanese politics have made me skeptical that meaningful structural change is possible.  The forces of the status quo are just too strong.  That’s also despite the will of Japanese citizens that such reform take place.  (In many ways, too, I see Japan today as like the Ghost of Christmas Future for the US.)

the Kuroda message

Late last week, an interesting thing happened in Tokyo.  In an interview with the Wall Street Journal, Haruhiko Kuroda, a career politician who is currently the head of the Bank of Japan (the equivalent of the Fed in the US), urged Mr. Abe to get going on structural reform.  “Implementation is key,” he’s quoted by the WSJ as saying, “and implementation should be swift…The major work to be done is by the government and the private sector.”  Bad things will happen to the economy otherwise.

Mr. Kuroda’s bluntness contrasts sharply with the wishy-washy statements en Bernanke has made before the US Congress about the need for supportive fiscal policy–none of which has been forthcoming–to aid the recovery in the US.

Of course, the stakes are much higher in Japan, where currency depreciation has caused a loss so far of about a quarter of the nation’s wealth, and a corresponding reduction in living standards for average citizens.  This enormous cost can only be justified if it results in structural reform.  But so far just about nothing has happened.

what needs to be done

Yes, Mr. Abe pointed out to the Journal in a response to Mr. Kuroda that electricity prices have come down and that protection of domestic rice farmers has been reduced a bit.

On the other hand, all the legislation enacted in the 1990s to prevent foreign companies from having any influence in the running of Japanese firms (takeovers of any size are virtually impossible) is still on the books.  Shareholder activists, foreign or domestic, are as unwelcome as ever.  Major Japanese investment institutions, presumably with government “guidance,” continue to take a hands-off attitude toward the companies whose stock they hold.  And companies themselves, other than perhaps the autos, seem to be in no rush to modernize the industrial practices that have caused so much economic hardship since the 1990s.

And, as Mr. Kuroda observes, time is running out for Japan.  The kind of positive jolt that deficit spending/currency devaluation/uslta-loose money give to an economy only lasts for a few years.  Without other changes, an economy gradually settles back into its former lower-growth state, only with higher inflation.  In other words, the economy in question is worse off than it was before.

For the sake of Japanese citizens, I hope Mr. Abe starts working on arrow #3 before it’s too late.  Unfortunately, almost thirty years of watching Japan tells me he’ll end up posturing a lot but doing nothing.  The only chance I see for a better outcome is if other politicians follow Mr. Kuroda’s lead and begin to speak out.  Unless/until this happens, I think the Tokyo market will continue to be an unpleasant place to be.






Japan joins the QE party

Japan’s QE

Two days ago, the Bank of Japan announced it is following the lead of the ECB and the Fed in launching a new round of Quantitative Easing (a term invented by an economist apparently obsessed with the Queen Elizabeth line of ships).

the EU starts, the US follows

The rationale for the European Central Bank to act is clear.  It is in effect using funds from the stronger EU economies to prop up the bond markets of debt-laden and uncompetitive Spain and Italy while they restructure their economies.

Why QE3 in the US is somewhat less clear.  The Fed is propping up the domestic mortgage-backed securities market, while simultaneously assuring investors that short-term interest rates will remain low for the next three years.   This will certainly be good for housing prices.  Addressing the looming “fiscal cliff,” or, better still, reforming the tax code would be much more effective confidence-building steps.  But these are the province of the White House and Congress.  QE3 is all the Fed can do.

The Fed’s intent is to create more jobs.  These might come either in direct fashion from a new residential construction boom (which wouldn’t be a good thing, in my view), or indirectly from the “feel-good” factor that stable or rising home values would produce.

The Fed realizes its action may do nothing.  But its attitude seems to be that it’s better to light one more candle than to stand by and watch the labor force erode through chronic unemployment (see my post).

Japan’s motivation

Japan’s motivation is murkier still.  If EU and US money policy become looser, then simply by doing nothing Japan’s becomes relatively tighter.  This change won’t make itself felt through lower nominal interest rates, which are close to zero anyway.  But the new tightness should manifest itself in relative strength for the ¥ versus the € and the $.

So far, however, that hasn’t happened.  The ¥ has weakened against its strongest trading rival, the €, and strengthened only mildly against the $.  Nevertheless, the Bank of Japan appears to have chosen to draw a line in the sand for its currency at the level of $1 =¥78.  It’s doing so to assist domestic export-oriented industry.

Yet, the central bank must know that such currency defenses seldom, if ever, work.  And it must realize that currency strength isn’t the main problem. Rather, the Japan Business Association (Keidanren) is lost is dreams of the glory days of a quarter-century ago.  Ex the big auto manufacturers, Japanese exporters haven’t evolved since then.  In newer areas, they have been surpassed by the US, in older sectors by Korea and China.

the essential differences

The ECB is acting because it sees no other choice if it wants to preserve the Eurozone.

The Fed thinks there’s little downside to its actions, and they may do some good.

Both central banks are seeking to stimulate their domestic economies.

Japan, on the other hand, is trying to defend its trade position.  And it’s “buying time” for adjustment for a sector that hasn’t changed in 25 years.  Not a great way to make a living.

From an investment perspective, even though the motivations of the various central banks may be different, the overall effect is that more money is sloshing around looking for a home.  In the near term at least, that’s good for global stock markets.

quantitative easing in Japan: implications

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.