Party On

The US equity party continues unabated this morning, despite the report overnight that Japan entered the next stage of the end game.
Another negative quarter means that Abenomics and the massive QE from the BoJ has failed. While the weakened yen has certainly raised input prices, it has failed to spur export demand as the rest of the world is slowing. The result has been pain for the Japanese consumer, exacerbated by a small sales tax increase from a government that borrows half of its spending. Abe will almost certainly postpone or cancel the next planned increase in the sales tax, leaving Japan’s government debt to continue its parabolic surge until…?

Logically, Japan’s interest rates should rise as the risk of default increases, but that won’t happen because the only buyer is the BoJ – there is no other source of liquidity in the market. Well actually there’s no market. It really doesn’t matter then, because the Japanese government debt is essentially all being converted into new cash liquidity.

So the consequence of this seems to be a steadily weakening yen. Down 35% from its 2011 peak, the yen is now firmly in the middle of its trading range since the early 1990s. Not a huge concern, really, with that perspective in mind. However, its previous trading range until the mid-80s was another 50% lower and we could easily be going back there, when Japan was selling mostly on price, not quality. Of course, this would be horrible for Japanese consumers, given that prices of imported food and energy would soar. It is not unreasonable to believe that this would result in the political upheaval that is so badly needed to get rid of the moribund LDP and the feudal bosses. One can hope, I suppose.

But there is no painless way out that I can see. It is too late for that. Perhaps the most important takeaway is that Japan will continue to make every effort to boost growth by cutting export prices. It has no choice, even with enthusiastic domestic consumers the demographics are merciless as Japan ages. So the world’s second or third largest economy will be exporting deflation as hard as it can. Think about that.

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