Friday, March 8, 2013

The big news is a weaker yen (update)

Six weeks ago I noted that one of the biggest changes on the margin was the sharp decline of the Japanese yen and the equally sharp rise of the Japanese stock market. This meme is still alive and well, and here are some updated charts:

Since the end of last September, the yen is down almost 20% vs. the dollar. According to my calculation of its Purchasing Power Parity, the yen is still somewhat overvalued, but much less so now that it was just a few months ago. A very strong yen represents a deflationary force that was suppressing the growth of Japan's export sector, a key part of the economy. So a less-strong yen should be good news for the Japanese economy, since the yen has been appreciating on and off for the better part of the past 30 years.

Since mid-November, the Japanese stock market is up 40%. It is still quite low from an historical perspective (recall that the Nikkei 225 hit a high of 40,000 at the end of 1989), but now much less so.

This chart compares the value of the yen with the level of the Nikkei 225. Note that the correlation has been quite high for years now. A chronically stronger yen (as shown by the declining red line) has corresponded with a weaker stock market. Now things seem to be changing, and in a big way, thanks to new leadership from Prime Minister Abe which seeks to stimulate growth by relaxing Japan's notoriously-tight monetary policy.

If "Abenomics" does prove beneficial to Japan's economy, as the stock market suggests, this will also be good news for the rest of the world.


Ed R said...

Why is more inflation (i. e. less deflation) in Japan 'good for the rest of the world' but more inflation in the USA is not??

Scott Grannis said...

Ordinarily, I would say more inflation is a bad thing for any country.

But in Japan's case, more inflation is good because the country has suffered from too much deflation. It needs "more inflation" in the sense that it needs less deflation. It's all about the yen, which has been rising against every other currency on the planet for decades. Japan needs a yen that is less strong and more stable.

Export industries have been hammered by a steadily appreciating yen, because they can't sell their stuff overseas for enough to make a decent profit. Imagine an industry that constantly has to sell its products at a price lower than was anticipated when the factories were built. Plus, the ever-stronger yen means that imported goods and services are constantly declining in price, and that creates very stiff competition for all domestic industries.

A less-strong and more stable yen will "level the playing field" for Japan's industries, making it easier for them to expand, and for the economy to grow. A stronger Japan is in everyone's best interests (the global economy is NOT a zero sum game). A stronger Japan can sell more goods and buy more goods. A stronger Japan contributes to a rise in global productivity and global living standards.

Stable currencies and stable prices are always better than ever-appreciating currencies and falling prices, and always better than ever-depreciating currencies and rising prices. Why? Because stability enhances confidence, and confidence and stability are breeding grounds for productive investment that leads to more growth.

Benjamin Cole said...

I am happy to say I agree with Scott Grannis.

And that he should apply his excellent logic to the much-ballyhood and hallowed "strong dollar."

I do not know that currencies, in free markets, can be stable, if by that Grannis means exchange rates stays the same over decades.

There will be long-term secular trends.

A more trade-oriented dollar, one that encourages US exports, might be a good idea.

There is the reality that the USA prints up an international reserve currency meaning that we print money and people give us goods and services in exchange. This is a very appealing situation to be in, though death on domestic industries.

I expect that in the long-run the dollar will stay about where it is, or "decline." A decline would benefit domestic industries.

terex said...

I cant help wonder how the thinking goes in Tokyo. Since Abe has a inflation target of 2% and at 2% in average interest rate I think that more than 2/3 of publ. revenue will go to interest payments. Now this doesn't happen all at once of course, but if inflation starts picking up, shouldn't markets get nervous over increasing interest rates? And even more interestingly; how does BoJ plan to react to rising interest rates (they should have a plan since this is a consequence of their goal of an increasing inflation rate)?

Is BoJ taking a BIG bet on weak yen and rising foreign trade surplus to save trade balance and current account -and financing? Or what is the plan?

Unknown said...

Scot what is the reason for the massive declines in the closed end muni fund market? I get the fear of inflation and the Fed, but I can't find anything to explain this latest 3 week selling going on in this market. Your thoughts will be deeply appreciated.