In a past video made in collaboration with our friends at Value School we told you why Japan
is one of the countries with the least foreign direct investment in the world. In this video
we are going to focus on the latest "crisis" that the Japanese economy is going through.
VisualPolitik community, between September 2021 and May 2022 the Japanese yen has lost
one fifth of its value against the dollar. And considering that we are talking about one
of the most important currencies in the world, this is a more than considerable gap. In fact,
in Japan it is something that has set off all the alarm bells. For the first time in two decades,
the value of the dollar exceeded 130 yen. And that's not all. Since the yen achieved
a record high against the dollar back in mid-2012, the Japanese currency has lost
40% of its value in the intervening years. And the questions we are wondering are:
Why is the value of the yen plummeting? Why does it seem to worry so many analysts so much and
even the Japanese government itself? And since this is a Value School topic, one last question:
What consequences could it have on the markets? Well, let's take a look.
(A BLOW FORETOLD) 2022 brought with it a
major economic turnaround: after many doubts, numerous hesitations and a very slow start,
the market now seems to be completely convinced: The Federal Reserve will carry out the most
aggressive tightening of its monetary policy in decades. With inflation levels exceeding
all forecasts, rates seem doomed to rise sharply... At least in the United States.
In Japan, on the other hand, things are totally different. While the Fed was trumpeting its
intention to fight inflation, the Bank of Japan came out to make clear its firm decision that
it will use every means at its disposal to indefinitely cap the yield on 10-year
Japanese government bonds at 0.25%. To give you an idea, the yield on the
10-year US government bond crossed the 3% mark in early May 2022.
But how can a central bank limit government bond yields? Any ideas? 3, 2, 1... Exactly! By
buying massive amounts of government debt with new money. What is popularly known as printing money.
And this, this was already too much. After the announcement,
many investors and savers began to liquidate their yen and convert them into dollars.
The objective? To protect their savings and try to get a higher
return on them. Because it is clear that the Japanese government's 0.25% is hardly worth it.
The fact is that, according to OECD data, this reaction has caused the
yen to undervalue against the dollar more than at any time in more than 30 years.
However, the fact that it is undervalued does not mean by any stretch of the imagination that
its value has bottomed out. The huge divergence between the monetary policies of the United States
and Japan could end up dragging the Japanese currency down even further.
So the question we can all ask ourselves is: Why are they so intent on limiting government bond
yields? Why does the Bank of Japan insist on further fueling its ultra-expansionary
monetary policy? What is it trying to do? Well... You see, first of all we could
think that this is about "rescuing" the Japanese government or at least making
it easier for it to keep spending more and more without having to raise taxes.
Remember that we are talking about a country where the nominal government debt is 240%
of GDP, so that an increase to 1% or 1.5% in the yield on public debt could end up
costing the Japanese government more than $120 billion per year in interest alone.
But no, in principle that is not the main reason. The truth is that, for a number of years now,
the Tokyo hierarchs have been coming to one conclusion:
The Japanese economy can only be driven by exports. And that is not
all. They also believe that in order to maintain their upward competitiveness,
above all they need a weak yen to make Japanese products cheaper on the international market.
On the other hand, we cannot forget that one of the main objectives of Japan's central bank is to
fuel inflation. This is a country that is already suffering from a significant contraction of the
working population due to demographic aging, which is putting downward pressure on prices.
Well, this is why the central bank intends to boost the export sector and encourage
both investment and consumption through credit with more monetary injections.
However, hold on a minute, because objectives are one thing and results are quite another. This is
not the whole story so to speak. As many Western analysts point out, this policy could end up being
a huge mistake. Listen up.
(THE HIDDEN FACE OF DEVALUATION)
In 2021, Japan recorded an average monthly trade deficit of about $1.2 billion. In fact,
if we take a look at the data, we can see that since 2012, and despite the fact that the yen
has lost 40% of its value, the external balance has ceased to be favorable.
What’s more, Japan's exports account for around 17.5% of its GDP,
a higher percentage than that of the United States, but one which is much lower than
that of countries such as Canada or the United Kingdom, which export a quarter of their GDP,
let alone Germany, where exports account for 47% of GDP, almost three times the level of Japan.
That is to say, although we all relate Japan's economy to its global exports,
with the data in hand, the Japanese economy does not seem to be so specialized
in the foreign sector. What it is, in contrast,
is an economy highly dependent on imports of all kinds of raw materials.
And of course, if we add to this the increase in the price of energy,
food and minerals the falling value of the yen, then it all points to a major economic shock:
imports are growing much faster than exports and if things continue this
way the purchasing power of the Japanese may suffer considerably.
In fact, a recent Reuters poll showed precisely how Japanese companies are beginning to be
seriously concerned that the falling yen could unduly weaken consumption and capital investment.
To make matters worse, the global economic slowdown and particularly the impact that the
zero COVID policy is having on China may slow down Japanese exports. Because yes,
it is China that is the main market for Japanese exports. Check it out.
The fact is that if this slowdown occurs, the Japanese economy could have a significant hole
in its external sector, which in turn would contribute to further depressing
the value of the yen. And with it the purchasing power of Japanese consumers.
And, take note, because this may not be the only consequence.
The fall of the yen could also induce other rival economies in the region to follow suit,
meaning that we could end up seeing a devaluation war between Asia's major exporters.
After all, if one country's currency is devalued, in the short term it weakens
the competitive position of another country. In this case it means that it becomes cheaper to buy
goods from Japan than, for example, South Korea because the yen is now cheaper than the won.
And exactly the same is true for the rest of the countries.
And guess what? No sooner said than done. Look at this chart for example: In response to the
fall of the yen, China has already started to drop its currency against the dollar.
Of course a devaluation war is not a particularly good thing for anyone.
Yes, it may temporarily benefit the United States and Europe as buyer countries,
but ultimately the imbalances generated can often lead to higher costs.
In 1997, when Japan devalued the yen to try to recover from the bursting of its real estate
bubble, it put pressure on other countries in the region to do the same, making it difficult
to meet dollar-denominated commitments. The result? The great Asian crisis of 1997.
VisualPolitik fans, Japan is a country with many virtues and its economy has
made significant strides in recent years: for example, its advanced industry has regained
world leadership positions, per capita economic growth exceeds that of many European countries
and the country is beginning to have some success in mitigating demographic aging.
However, the Land of the Rising Sun also has serious problems with its economic model.
Closing its borders to Foreign Direct Investment while seeking to gain
competitiveness by devaluing its currency is not usually an effective long-term strategy.
In a future video, by the way, we'll tell you about the problem with their publicly
traded companies, but for now, it's your turn: Do you think governments and central banks should
devalue their currencies to gain competitiveness? How will Japan's economic plan end up?
Leave us your impressions below and if you found this video interesting, hit the like
button and subscribe to Value School. All the best and see you next time.