Tag Archives: Japan

parity party on the calendar–the yen and the penny?

April 14, 2013 By in Asian economic development, currency effects, economics, Japanese development Tags: , , , , , , , 1 Comment

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.”

recent world currency movements: stock market implications

January 30, 2013 By in Asian economic development, currency effects, Current Market Thoughts, economics, Foreign markets, Japanese development, Portfolio management, Recent Market Action, Shaping a portfolio for 2013, Strategy Tags: , , , , , , , , , , , Leave a comment

dramatic changes

Although currency movements sometimes can often be overlooked by a stock market investor immersed in the hustle and bustle of day-to-day trading action, there have been a couple of whopping big moves in major currencies over the past half-year.

Since late July 2012, the euro has risen by 12.5% against the dollar.  Over the same time span, the yen has fallen by about 16.5% against the greenback.  A quick bit of multiplication tells us this also means that the euro has risen by about 30% against the Japanese currency.

To my mind, there’s no really satisfactory general economic theory about how currencies work.  But to give a sense of perspective, inflation in Japan has been, say, -1% on an annual basis over the second half of 2012.  We’ve had +1.5% in the US.  Euroland has experienced a 2.5% rise in the price level.  Inflation differentials imply that the yen should be rising against the dollar at a 2.5% annual rate and against the euro by 3.5%.  The euro, in turn, should have weakened by 1% against the dollar and 3.5% against the yen.  The actual outcome has been far different.

Of course, there are reasons for the spectacular assent of the euro and the plunge of the yen.  Until around mid-year, many observers thought Euroland was coming apart at the seams and rushed to get their money out before the demise.  I’m sure there was more than a touch of flight capital mixed in the outflows.  Thanks to Mario Monti’s and Angela Merkel’s actions indicating the political will to save the euro, capital flows have reversed in spectacular fashion.

Newly-elected Japanese Prime Minister Shinzo Abe made it a central plank of his campaign for office that he intends to force the Bank of Japan to print lots of money.  Why?   …to weaken the yen and to create inflation.  The move could easily end in eventual economic disaster, but for now its main effect has been to drive the Japanese currency down a lot versus its trading partners’.

stock market implications

Generally speaking, a rising currency acts to slow down the domestic economy.  A falling currency gives the economy a temporary boost.

Currency changes can also rearrange the relative growth rates of different sectors.  The best-positioned companies will be those that have their sales in the strongest currencies and their costs (e.g., labor, raw materials, manufacturing) in the weakest.

Japan

The decline of the yen has given Japanese export-oriented firms a gigantic relative cost advantage against European competitors, and a significant, though smaller, one against US rivals–or those located in any country that ties its currency to the US$.  Anyone who sells products in Japan that are imported, or made with imported raw materials, has been crushed.

We’ve seen this movie before, however, on a couple of occasions.  It’s ugly.  Domestic firms lose.  Exporters will make substantial profit gains in the local currency.  But from a stock market view, that plus–with the possible exception of the autos–will be offset for foreigners by currency losses they have/will endure on their holdings.  Stocks in even the most advantaged sectors will deliver little better than breakeven to a $ investor, and will certainly rack up large losses to anyone interested in € returns, in my view.

Euroland

The EU has already had a return-from-the-dead rally, where stocks of all stripes in the economically challenged areas of southern Europe have done well.  The message of the stronger currency is that importers, or purely domestic firms in defensive industries will fare the best from here.    Although I think the preferred place to be from a long-term perspective is owning high quality export-oriented industrials, the rise of the euro has blunted their near-term attractiveness.  One exception:  multinationals based in the UK, because sterling hasn’t participated in the euro’s rocketship ride.

Ideally, you’d want a firm that imports Japanese goods into the EU.

the US

Americans are less accustomed to thinking about currency effects that investors in other areas, where their effects are more pervasive.  With the dollar being in the middle between an appreciating euro and a depreciating yen, currency effects will be two-sided. Firms with large Japanese businesses, like luxury goods companies, will be losers.  Firms with large European assets and profits, like many staples companies, will be winners.  Tourism from the EU will be up, from Japan, down.  One odd effect, which I don’t see any obvious American publicly listed beneficiary–the decline in the yen is causing the cost of living for ordinary Japanese to rise sharply, since that country imports so many dollar-price raw materials.  To offset that effect, Japan is beginning to weaken protective barriers that have kept much cheaper finished goods (like food) from entering the Japanese market.  Doubly bad for Japanese farmers, though.

the yen is now too weak to suit Tokyo?

January 17, 2013 By in Asian economic development, economics, Japanese development Tags: , , , , , Leave a comment

In recent national elections,  the Liberal Democratic Party, led by former prime minister Shinzo Abe, seized control of the Diet, running on a platform of causing the yen to weaken against the currencies of Japan’s trading partners.  The idea was to break the quarter-century trend of domestic economic weakness by giving a temporary boost to export-oriented manufacturing and to try to end the deflation that has plagued the country since the early 1990s.

Since this idea was first suggested–the inept Democratic Party of Japan was certain to be tossed out in any election–the Japanese currency has fallen by almost 15% against the US$.  Now, in a reversal of form, the LDP wants the currency depreciation to stop.

What’s going on?

Why should it matter to the rest of the world?

The Japanese economy is like a slow-motion train wreck.  So it has a certain morbid fascination to it.  Perhaps more important, for the EU and the US,  Japan is like Dickens’ Ghost of Christmas Yet to Come.  Japan has written the manual on how not to run a developed economy with an aging population.  Hopefully, Brussels and Washington are taking note.

Three points:

1.  Except for developing economies dedicated to radical economic transformation, currency depreciations never work.  Export-oriented manufacturing may get a temporary boost.  But that quickly fades.  Inefficient companies just put off necessary restructuring.  So the economy is soon back in the same sorry shape, only with higher inflation.  In other words, economically speaking, this was a crazy idea.

2.  Politicians normally choose currency depreciation over more effective adjustment methods mostly because it’s invisible–so they can deny responsibility.  It isn’t the legislators who are inflicting pain on the economy, after all, it’s the (evil) foreign currency markets.  In this case, however, even the political rationale doesn’t hold.  Currency depreciation, over the protests of the Bank of Japan, is the centerpiece of the LDP economic program.  So the LDP gets all the blame.

3. The costs of currency depreciation, in terms of national wealth, can be immense.  In Japan’s case, the cost of goods and services produced abroad is suddenly 15% higher than it was last October.  This doesn’t just mean foreign vacations or real estate purchased by the wealthy.

It also means food, clothing, fuel, electric power–anything imported into the country.  Looked at a different way, the after-tax purchasing power of Japanese savers and wage earners has just shrunk by about a quarter, almost overnight.  What a disaster!  I think it’s citizen uproar over higher prices for everyday necessities that’s causing the LDP’s about-face.

I hope the LDP has a backup plan.

 

 

the latest Japanese election comes on Sunday

December 14, 2012 By in economics, Japanese development Tags: , , , , , , , , Leave a comment

getting scared straight

Cable network A&E is now into its third season of Beyond Scared Straight. This is the latest iteration in the Scared Straight genre, created in the 1970s, in which budding criminals visit prisons and are supposedly frightened back onto the straight and narrow by Ghost of Christmas Yet to Come-like interaction with the inmates.  I’ve never had enough interest to try to figure out how much is real and how much is staged.

There is a real-life Scared Straight, though, for economics and public policy.  It’s called Japan.  Maybe we should send our elected officials in Washington for a visit.

Japan

The Japanese economy has been in neutral for almost a quarter-century, during which the standard of living for average Japanese citizens has steadily eroded. The workforce is aging (it’s actually been shrinking for about a decade) but Tokyo doesn’t allow immigration.  Weak management is slowly (sometimes, not so slowly) killing even iconic companies, but foreign turnaround specialists aren’t allowed to take control.

Worse, the government borrows heavily to spend on pork barrel “stimulus” projects that yield no economic return.  As a result, national debt now exceeds 2x annual GDP. That’s a Greece-like number. Perversely, because Japan is almost devoid of good new investment opportunities (small “counterculture” companies run by younger managers are an exception), citizens continue to plow their savings back into government bonds, even though they yield next to nothing–creating a continuing cycle of misery. The Diet has not been overwhelmed by the interest expense of its reckless borrowing, nor has it had trouble, so far, in raising fresh funds to squander.

There’s an election on Sunday, in which the hapless Democratic Party of Japan is likely to be replaced by the Liberal Democrats, who have been the dominant force in modern Japanese politics.  The DPJ was voted in a few years ago to change the patronage culture, but almost immediately lost its way in a frenzy of intra-party bloodletting.

why the election is interesting–and maybe important

Shinzo Abe, who will become the Prime Minister if the LDP wins, is running on a platform that includes dismantling the independent central bank.  If Mr. Abe gets his way, the bank will be forced to print money as fast as the presses can turn, until this action creates at least 2% annual inflation.

Wow!

I guess the idea is to weaken the currency so that even arthritic export-oriented manufacturing companies will be able to make a profit.   There’s also the “advantage” that the currency markets, rather than the legislature, may take the blame for the immense loss of national wealth that would ensue.  At the same time, to the degree that the LDP is successful in creating inflation, it will also likely triple or quadruple the interest rate on new government debt–potentially making it impossible for Tokyo to service.  Scary.

Implosion isn’t imminent.  Mr. Abe hasn’t won yet.  Maybe he’ll change his tune after he’s in office.  Maybe the Bank of Japan won’t simply roll over and do what he says.  But, to mix metaphors a bit, that’s kind of like saying that the fuse to the dynamite that’s being lit is very long.  Japan could be an Asian version of Greece if a few years.

the really scary part for the US

In a nutshell, Japan’s basic problem is that since the early 1990s it has chosen to prop up the status quo, in the face of a changing world, no matter what the cost.  What’s really scary for an American is that Washington seems to be taking a turn down the same road.

foreigners now own more Japanese government bonds than any time over the past thirty years…Why?

September 24, 2012 By in Bond Environment, Current Market Thoughts, inflation vs deflation, Investment firms, Japanese development, Strategy Tags: , , , , , , , Leave a comment

foreign JGB ownership continues to rise

The Bank of Japan announced last week that foreign ownership of its government bonds has now reached  the highest level since 1979.

The foreign investors piling in aren’t individuals like you and me.  They’re mostly professional bond investors who manage mutual funds and institutional pension accounts and, to a lesser extent, non-Japanese central banks.

What’s the attraction?

To the layman’s eye, there would seem to be none.  The Japanese economy hasn’t grown much for over two decades.  The Tokyo government continues to borrow heavily to run its operations, so the stock of JGBs continues to expand.  And interest rates are extremely low.

There are, however, two positives.

90% or more of Japan’s government bonds are held by Japanese citizens and institutions.  They regard JGBs as the ultimate safe investment.  They also see themselves as having little other choice (without taking unacceptably high amounts of risk) than to continue to hold.  They roll their money over into new bonds when their current bonds are redeemed, too.  So–unlike the case with, say, US Treasuries, where foreigners own about half the outstanding bonds–there’s little chance of the JGB market being roiled by panicky foreigners repatriating funds to the their home markets.

Also, the Japanese economic situation is well-known.  It has been for all practical purposes unchanged for over two decades.  Chances of any change appear to be slim.  To boot, in the deflation-prone Japanese economy, low yields look somewhat better in inflation-adjusted terms.

In other words, although you won’t make much money–other than a possible currency gain–the chances of a loss appear to be very small.  That’s what makes Japan so attractive to global bond professionals.

not so in the rest of the world

The sub-prime mortgage crisis in the US and the Greece/Italy/Spain government debt crisis in the EU have driven bond yields for Treasuries and for German governments to within striking distance of JGB yields.  In fact, short-term German government notes trade at negative yields.

Inflation-adjusted, Treasury yields are already negative, as well.  It’s possible that economic recovery now under way will eventually cause inflation to rise further, worsening this situation–and causing the Fed to raise rates.

In Germany’s case, if the Eurozone is to survive it looks like Germany will have to accept more inflation than it traditionally has been willing to do.  It will also bear a large amount of the cost of bailing out profligate Spain and Italy.  (Greece?  It’s too small to matter; my personal bet is that Athens will be eventually expelled from the EU.)

in short

Marketers of bond funds continue to tell us that bonds are a good place to have our money.  If we look at what those managers are doing with any funds we give them, however, we see the best low-risk option they’re able to find is Japan, whose virtue is that losses will probably be minimal.

Another case of:  watch what they do, not what they say.