Friday, October 31, 2014

Japan shakes things up

Back in early January of last year I had a post titled "The biggest news is the weaker yen." Japan had shocked the world with news that it was finally getting serious about stimulating its economy. Perhaps most important was the news that the BoJ wanted to reverse the decades-long, relentless strengthening of the yen. The perpetually strong and stronger yen was the source of Japan's deflationary slump (even though there wasn't much actual deflation). A continually rising yen was strangling Japan's manufacturers and exporters, since they were continually forced to lower their prices to compete with overseas rivals. A weaker, more reasonably-priced and more-stable yen would be a significant first step to reinvigorating Japan's economy.

Today the yen dropped significantly, returning to levels last seen about seven years ago, on news that the BoJ was redoubling its efforts to provide monetary stimulation by aggressively expanding the monetary base. The stock market responded by also jumping to levels last seen seven years ago. The tight, inverse correlation between the value of the yen and the value of the stock market confirms that the strong yen was a big problem for the Japanese economy.

According to my calculations, the yen is now back to levels that are very close to what I consider "Purchasing Power Parity" with the dollar. It's reasonably priced. It's not weak, and it's not strong. It's now a neutral, rather than a negative factor for the economy. The future of the Japanese economy looks brighter. What will really make a difference, however, is a decision by the Japanese government to also adopt genuine fiscally-stimulative measures such as lower marginal tax rates, reduced government spending, and reduced regulatory burdens.

In the meantime, the world was also shocked this morning to learn that the investment guidelines of Japan's (and the world's) biggest pension fund, which currently holds most of its $1.3 trillion in assets in very low-yielding bonds. At least half of this sum will be departing bond land in the direction of equity land, and that is a pretty aggressive move. It's a solid chunk of evidence that the world is becoming less risk averse. That's the broader and most important trend to be found in economies and stock markets around the world these days.


Benjamin Cole said...

The BoJ is boosting QE and institutional investors loved it. The market gave the BoJ the thumb's up.
Would the Fed have the resolve to follow.

William said...

The BOJ has to be the most incompetent central bank of all. It's just more of the same old, same old. Keep interests rates low!

And BUY HIGH the various markets i. e. RIETs, ETFs, etc. after they have risen 100% in two years. Is that not outright market manipulation.

During the Asian Currency crisis of 1998, that Hong Kong central bank bought equities after they had fallen 60%. At the time, it was roundly criticized for market manipulation. But at least they were smart enough to BUY LOW and they made a handsome profit on their purchase.

Benjamin Cole said...

William: There are a lot of unintended negative consequences from a do-nothing central bank--that has been the lesson of Japan.

Finally, the BoJ is getting halfway serious.

What is frightening is the imprudent do-nothing stance that the Fed is re-assuming.

William said...

@Benjamin Cole

Japan's problems are primarily demographics - an aging population and zero immigration -; protectionism for farmers especially rice growers; and extremely rigid labor laws and business laws. Fundamentally Japan will never get out of its quagmire until the politicians have the courage to tackle the above issues.

Otherwise, like Germany, Japan is a mercantilist economy dependent upon exports and bugger thy neighbor policies.

Benjamin Cole said...

William: for sure every modern economy has structural impediments. Suffocating the economy through tight monetary policy does not cure those structural impediments.

rakuten said...

The BOj vote was 5:4, very rare in consensus loving Japan. At the same time two of Abe's newly appointed ministers were forced to resign shortly after their appointment due to leaks of party funding irregularities.

Make no mistake, behind the scenes there is an epic fight between team Abe/Kuroda and the bureaucrats, led by the MoF. In Japans history so far the bureaucrats have always won in the end.

Benjamin Cole said...

Dear ce: it is monetary policy that makes American women act this way.

NormanB said...

The close correlation to a currency (Yen vs Dollar) and the currency's stock market has historical precedent. During the German Mega-Inflation stocks were a good refuge so that purchasing power was preserved for those who held stocks.

Also, China will follow Japan so watch for their stiumuls. The reason>: China wants to maintain its realative export position.

M Miller said...

Keep an eye on the massive amount of foreign debt that is dollar denominated. the dollar will keep going up and it will create a massive increased liability and kill many issuers. What for warning signs. Everyone that can pay off this debt early or hedge, they will. Those that can't, won't, until they start to warn. Watch for this issue.