Reports of Japan’s Death are Premature

By Peter Pham - August 15, 2012 | Tickers: FXY, HMC, TM | 0 Comments

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In recent months it has been very fashionable to look at Japan’s demographics and level of public debt and conclude that the end is nigh.  All it will take is a little nudge and sayonara goes the once great Asian tiger.  The latest iteration of this story is that the strong yen is going to drive what is left of Japan’s export economy over a cliff.  This will send their trade deficit skyrocketing and then that will be the beginning of the end. 

But Japan has been dealing with a strong Yen versus the US Dollar for years.   Since 2002 the Yen has dropped from a peak at 133 to the Dollar to today’s price around 78.  Anyone who bought the CurrencyShares Japanese Yen ETF (NYSEMKT:FXY) made themselves very good money since the Fed began QE1 back in 2009, even if it pays almost no dividend.  The Yen dipped as low as 76 this year and looks relatively stable between there and 80. 

Rejecting Mercantilism

But it took a massive earthquake and tsunami to wipe out a whole prefecture to turn Japan’s trade balance negative to procure the goods needed to rebuild.  The Yen strengthened due to funds being repatriated from overseas.  It didn’t hurt matters that Europe was beginning to implode making the capital flight back home not only good community but good business sense.  Through the 1^st half of this year Japan has posted a trade deficit of $37 billion USD as LNG and crude oil imports continue to dog their economy while they restart their nuclear reactors. 

Remember that a country like Japan has to import nearly everything it winds up exporting because it’s not like it is an island blessed with an overabundance of natural resources.  One has to remember that currency effects on imports and exports are a double-edged sword.  What is good for the exporter, debasing the currency, is bad for importers.  In essence, currency manipulation like that essentially just picks winners and losers within a country’s economy. 

Since the 1990’s Japan’s zero-interest rate policy has slowly worked off the effects of the currency debasement they used to build bubbles in both the Nikkei and the property markets.  There has been a transfer of debt from private and corporate into public hands.  But the public debt is being rolled over at ever decreasing interest rates.  The biggest pile of which hit their treasury in 2011.  From now until 2020 the amount of debt to be rolled over will decrease every two years.  So, as long as yields remain low the burden on the government budget will remain relatively benign at 21-23%.

The Yen to Invest

The strong Yen has caused a flourishing of investment around Southeast Asia.  In 2011 FDI outflows from Japan doubled and the numbers from places like Vietnam for 2012 are even more impressive, with $4.3 billion US being invested, a more than 200% increase over all of 2011, itself a record for Japanese investment there. 

One of the main arguments for the death of Japan is their rapidly aging population.  But in a world of global, or at least regional, investment and trade, young and cheap Vietnamese working for Honda (NYSE: HMC) building scooters are a part of Japan’s productive labor pool.  It’s a kind of virtual immigration in that respect.  Major Japanese companies like Toyota (NYSE: TM) are finally having to bite the bullet and outsource more of their production overseas. 

This is an advantage for Honda and Nissan over Toyota as they have moved 75% of their production offshore, while Toyota still makes 40% of their cars in Japan.  That will change drastically in the next 10 years as the vehicle markets in India, Thailand, Indonesia and China grow.  The strong yen is having little effect on their ability to sell cars this year.  Toyota could easily top their latest guidance and hit the 10 million vehicle mark in 2012.

Fear Management

Lastly, when looking at the recent shift in the markets, it is obvious that the bull run in U.S. Treasuries ended recently, peaking on July 25^th.  If the death knell was sounding for sales of Japanese government securities, they would at least be keeping pace with U.S. ones as both countries saw massive capital inflows since the Greek default in March, but that’s just not the case. 

U.S. Treasuries are being sold faster than their Japanese counterparts.  This means a number of things but all of them bullish for Japan with respect to the U.S., which is what is important at this point.  China is increasingly becoming a more important part of Japan’s economy, now accounting for just over 20% of their trade. 

All of the major central banks are going to print and print a lot over the next few years.  There will be unprecedented currency debasement, that much is given.  What is important to keep in mind is not the amount of money created but the rate at which it is.  Japan is continuing to print at a slower rate than the U.S. and Europe because they are in better shape overall with respect to finding takers for and servicing their debt.  While the transition to an Asia-dominated global economy takes place, Japan will be at the center of it, providing stability and liquidity while the west attempts to extricate itself from the mess they are in. 

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