Trouble in Japan and the U.K. add up to a stronger U.S. dollar
Expect the dollar to keep moving higher in the near term.
Credit rating worries in Japan and disappointing economic numbers in the United Kingdom pretty much guarantee that the U.S. dollar will continue to gain on the yen and the pound.
On January 25 Standard & Poor’s lowered its credit outlook on Japan’s AA-rated sovereign debt to “negative” from “stable.” Japan’s government doesn’t have a plan to cut its budget deficits, S&P said. The cost of protecting against a default on Japanese government debt within the next five years in the derivatives market rose by 0.05 percentage points to 0.9 percentage points.
The long-term worry is that Japan’s aging population and stagnating economy will eat into one of the world’s largest pools of savings. Domestic Japanese investors hold 90% of the country’s debt.
Is Japan betting its future on a new weak yen policy?
Add Japan to the list of country’s counting on a weak currency to dig their economies out of a hole.
On his first day in office new Japanese Finance Minister Naoto Kan lost no time in saying that he’d like a weaker yen. The Japanese currency is already down 9% from its November high of 84.83 yen to the U.S. dollar but it’s still 18% higher than two years ago.
That has killed Japanese exports—since a stronger yen makes Japanese products more expensive to overseas customers—especially since China has re-pegged its currency to a declining dollar. That’s had the result of making Chinese exports cheaper even as the Chinese economy has led the world out of recession.
The yen fell on the Finance Minister’s remarks in his first press conference. It was down about 1% against the U.S. dollar as of noon in New York.
Kan’s preference for a weaker yen reverses the policy of his predecessor Hirohisa Fuji who after taking office in September repeatedly said he favored a stronger yen as a way to bolster the spending power of Japanese families. Fujii famously called the notion that a weaker yen would help Japanese exporters absurd.” Fujii stepped down recently because of persistent health problems.
Exports led Japan’s recovery from its worst postwar recession, accounting for almost all of the 1.3% growth in Japanese GDP in the third quarter of 2009. Recently though Japan’s big exporters have shown signs of pulling back on capital spending. The most recent Tankan survey from the Bank of Japan reported that these companies plan to cut capital investment by almost 14% in the year that ends in March 2010. That’s the second worst projection in the history of the survey.
Japan’s consumers have shown little interest in picking up the slack. Retail sales, for example, have declined for 15 straight months. (For more on how the huge gamble by Japan’s Democratic Party government to revive consumer spending see my post http://jubakpicks.com/2010/01/04/japans-huge-budget-gamble-will-push-up-global-interest-rates/ )
Japan’s huge budget gamble will push up global interest rates
It’s a desperate gamble but Japan’s Democratic Party government, headed by Prime Minister Yukio Hatoyama, doesn’t have much choice.
To break the hold of deflation on the Japanese economy, the country has to spend money—lots of money—it doesn’t have to stimulate an economy that threatens to turn in a third straight year of negative growth in the fiscal 2011 year that begins in April 2010.
The government’s new budget calls for a record $1 trillion in spending for the fiscal year. But it’s not the size of the budget that’s so shocking. Government projections say that tax receipts next year will come to just $405 billion. For the first time since World War II Japan’s government will borrow more than it takes in from taxes.
That new borrowing—an estimated $485 billion—will bring the country’s total debt to $9.4 trillion by the end of fiscal 2011 in March 2011. That will be equal to 181% of the country’s GDP (gross domestic product) by March 2011. In other words Japan will owe almost two year’s worth of the activity of its entire economy.
How big is that debt burden? Let’s look at a few comparisons.
Deflation’s back in Japan–and why investors should care
Deflation has returned with a vengeance in Japan.
And we’re not talking about some short-term dip in prices either.
The Bank of Japan is forecasting that prices in Japan will fall by 1.5% this year, by 1% in 2010, and by 0.7% in 2011.
So much for any recovery in the Japanese economy.
Deflation is indeed a symptom of the woes in the Japanese economy. It’s created by excess capacity that drives down prices since companies are willing to cut prices to keep factories running at even partial capacity. It’s a sign that Japan’s export-based economy is getting killed in competition with cheaper Asian exporters such as China and Korea. And it indicates that Japanese companies facing slow demand aren’t investing in new capacity or hiring more workers.
But a period of prolonged deflation like Japan has suffered during long patches of the last decade and looks like it will suffer again for an extended period as the country moves from the “00s” to the “teens,” isn’t just a reflection of an economy’s woes. Deflation in this setting itself creates problems. For example, once consumers and CEOs become convinced that prices will keep falling they have a built in excuse for putting off buying decisions. Everything will be cheaper in the future, right?
In addition, if prices are falling, low risk investments paying seemingly ridiculously low interest rates become reasonable choices. If you’re money is safe, it will appreciate in value as prices fall even if the yield is 0%. This discourages risk-taking and saddles the country with a vast pile of under-performing investments—a problem for a rapidly aging country such as Japan facing huge future expenditures.
Flight from the U.S. dollar is pumping up Asian stock markets
You don’t need to be Sherlock Holmes to know where the money is going.
It’s elementary.
Investors are taking money out of the United States, which they see as lagging the global economic recovery, and putting it into Asia, which they see as leading the global recovery.
One consequence? The U.S. dollar is falling against just about every currency in the world.
Another? Asian stock markets are soaring. Even in countries like Japan where the domestic economy seems to be lurching into yet another deep, deep pothole on the road to recovery.
In the morning hours of the September 10 trading session in Tokyo the MSCI Asia Pacific Index gained 1%. The index is up 64% in the last six months.
Think there might be some froth in those markets? Look at how little it takes to move a stock in China, Japan, or Hong Kong right now.
