Japan: Catharsis Or Crisis?

Tyler Durden's picture

The recent landslide victory of the Liberal Democratic Party (LDP) on a platform that promised positive change for the long-struggling Japanese economy has thrust a somewhat forgotten Japan back into the headlines. Indeed, as Goldman notes, asset markets have already responded aggressively to the prospective changes with Japanese equity markets climbing to multi-year highs and the Yen declining to multi-year lows against the US dollar and the EUR. But, as Kyle Bass has recently explained, very real questions remain about the ability of the LDP and new Prime Minister (PM) Shinzo Abe to deliver on promises and break the damaging cycle of low growth and deflation that has become well-entrenched in the Japanese economy over the last five-plus years. These doubts are reinforced by concerns about the health of the domestic banking sector and of Japan Inc. in general. "Abe-nomics 'appears' positive, but for how long?" Goldman asks and Hamada's recent concerns over 'going too far' are very real - though in general Goldman's positive 'take' is a useful counter-point to Bass' somewhat more realistic apocalyptic endgame thesis.

Overall, Goldman believes the recent developments suggest a still positive outlook for Japanese assets despite their recent run, but it’s clear that promises will need to continue to translate into action - and some very difficult longstanding issues will need to be addressed - in order to sustain the recent positive momentum over the medium-to-longer term.

It's been a rocky path for Japan in recent years:

with the Japanese government taking over (it seems) all fiscal and monetary decisions:

But it appears things are approaching a tipping point one way or another with the following dates all important:

Is Japan on the verge of a financial crisis?

No, but it could become vulnerable to one over the next 5 years or so.

There are two factors to consider when assessing vulnerability to a financial crisis: solvency – the ability of the government to pay the debt that it has accumulated – and liquidity – the ability of the government to fund its deficit on an ongoing basis. There are large concerns about Japan’s solvency. Its debt/GDP ratio exceeds 200%, which is by far the worst in the world, and there is almost no hope in eradicating that debt. It also runs a large fiscal deficit owing to falling tax revenues, which is closely linked to anemic economic growth, and rising expenditures on public works and social security as the population continues to age.

But, in terms of liquidity, the situation is actually healthy, with high domestic savings to fund this deficit, as domestic investors continue to pour money into JGBs. That savings will likely be sufficient to fund the deficit for at least five years.

What are the headwinds to achieving higher growth and inflation?

Japan faces severe structural headwinds, particularly stemming from demographics. The population is decreasing and aging rapidly, which means fewer people in the workforce to support a growing social burden. We estimate that demographic challenges have reduced growth by 0.3 pp annually over the past decade. In order to envision meaningful and sustainable improvement in economic growth, these problems must be addressed through policies that work to increase the size of the workforce such as providing greater incentives and opportunities for women and the elderly, as well as foreigners to join the Japanese workforce. One of my main concerns about the economic policy proposals of PM Abe is that there is little focus on these demographic challenges and how to combat them.

I do not believe that monetary policy alone can solve all the structural problems, but I do think it can meaningfully increase growth and inflation if it can weaken the Yen further.

How essential is further Yen weakening to the economic recovery?

Very essential. In my view, the $/JPY needs to sustain a level of $/JPY 90 or weaker in order to see meaningful economic improvement and rising inflation; the best case scenario would be a relatively stable level of around $/JPY 95. The question of what is the right level is complicated because it’s not just Yen/Dollar that is important but also Yen/Euro and even more so Yen/Won for certain industries, such as the electronic industry, which competes with Korean manufacturers and has suffered tremendously from the very sharp move in the Yen/Won following the global financial crisis as the Yen appreciated against the US dollar and the Won depreciated. So you really have to look at the effective exchange rate, which is the weighted average of exchange rates of Japan’s trading partners. That said, I think a comfortable exchange rate is somewhere near the weaker level that persisted before the failure of Lehman Brothers in September 2008.

What do you think would be the most effective way to achieve further depreciation?

Exchange rates should not be targeted. Instead, exchange rates should be thought of as a byproduct of the right policies, and the right policies are the expansion of monetary policy, most likely through some type of QE, fiscal stimulus, and growth strategy, such as deregulation, and incentives for innovation.

USD/JPY has risen 14% since late September, in conjunction with a buildup in speculative Yen shorts off the back of PM Abe's forceful statements. This time around, we believe that PM Abe’s statements will need to be backed up with action to sustain (or extend) the recent move.

What have been the key drivers behind the recent move? History would suggest that interest rate differentials and risk sentiment are some of the most likely culprits but recent developments in rates and risk are only consistent with about a third of the JPy move. Two other factors are:

i) A deterioration in the external balance

ii) Speculation

The key culprit that likely explains the rest of the move is the buildup in speculative short Yen positions in anticipation of new deflation-defeating policies proposed by PM Abe. JPY speculative positioning on the exchanges has remained at very stretched short levels for 6 weeks now.

FX is a relative game and we need to bear in mind that the Federal Reserve is also engaging in QE. Thus the outlook for the Yen is not entirely clear cut. Given that the recent move in the Yen has been driven by speculation of change, the rhetoric needs to turn into action to sustain (or extend) the recent price moves.

But while Goldman remains medium-term constructive on Japan and believes a 'balance' will be found before a weaker JPY crushes the spending power and living standards of the domestic economy, the market remains completely mesmerized in its nominal (and perfectly correlated) rise...

and yet, the chance of a snap-back remain extremely high given the massively 'crowded' long Japan trade...


Source: Goldman Sachs

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de3de8's picture

About time they joined the party.

economics9698's picture

Anyone seeing the anti-Japanese propaganda flicks coming out of China?

A bad omen, some really bad shit coming out of the Peoples Republic of China portraying the Japanese as baby killers, rapist, decapitating animals, which they may have been, but…

When the Chinese economy hits the skids, and it is, the Chicoms will be more than happy to reduce trade with Japan to balance the books and even a few scores.  They already are.

War would not be out of the question.

It would not bother the Chinese one bit to see Japan suffer a financial tsunami.

Peterus's picture

When all basic methods fail the rulers, they go deep into debt and see no other way out - war is frequently the answear. It may in fact save very well both Chinese and Japaneese rulers to have some of "their citizens" kill each other. There are some risks, but if they don't choose war they are personally going to take severe losses. It's not like Japaneese people will continue playing this game when their living standards crumble... and in war time 12 hours in a factory for a bowl of rice might be even tolerable. After all - nation needs you.

Bicycle Repairman's picture

"When all basic methods fail the rulers, they go deep into debt and see no other way out - war is frequently the answer."

Frequently?  It is the answer.  Social engineering on steroids.

LongSoupLine's picture

Watch the movie "IP MAN" starring Donnie Yen to show you how China feels about Japan.

Great movie...and a true story.

LawsofPhysics's picture


China is to the 21st Century, what Germany was to the begining of the 20th Century. Both mercantilists believed their people and technology to be superior. China cannot, nor will they shut down the great manufacturing machine they have constructed.

BandGap's picture

Japan has an intrinsic arrogance unrivaled in Asia. Even in their current economic malaise they believe they are superior to both China and Koprea in almost every regard.


silverserfer's picture

Just joined the party?! Shit they just woke up from being passed out drunk on the floor from the party last week! they never left! 

max2205's picture

Is this a repeat?   I remember this from a while ago

Orly's picture

Abe and friends have been saying the same exact thing for months, so Groundhog Day may get stuck in your head.

There is a new wrinkle, though, according to ForexLive.com and that is that the BoJ may cut the interest on excess bank reserves to near or at zero.  Japanese government bonds pay diddly, so the money in Japanese banks just sits there, earning interest and isn't moving into the economy.  Sound familiar?


If the interest on excess reserves is brought to zero, banks may then be forced by the market to make loans to small businesses and take risks with the capital that they haven't done so far.

Of course, that is the idea but extrapolating what Kyle Bass said the other day, what is likely to happen is that Japanese banks will take this money and go invest in foreign real assets, such as plants and foreign bonds.

If the goal is inflation, lending to small business would spur inflation in the Japanese economy.  If the banks simply go and buy foreign stuff, then there is again no movement into the Japanese economy at all.

Therefore, I would expect this announcement to initially ramp the yen crosses but after a few days or weeks, it will become apparent that Abe's bank interest plan essentially back-fired and the yen crosses come off hard.  I mean hard.

Bass also said that the yen will be strongest just before the swaps market prices in inflation (for real...) into the Japanese economy, not from increased economic activity but the greater cost of financing their debt.  Once that happens, the whole kit-and-kaboodle says yippee kayay.

So, the EURJPY trade could move from 120+ to 85 in fairly short order, just before the pair goes asymptotic to the upside, indicating a complete annihilation of the Japanese economy.

It's gonna be wild!


css1971's picture

Well I personally wouldn't be accepting Yen for my house, so I suspect if they buy foreign assets then then the yen will appear in the forex markets dropping it's value and making raw imports more expensive.

i.e. exactly what we've seen since September.

Orly's picture

Right but the point is to release excess bank reserves to the average Japanese small businessperson, which would spur consumption and trigger inflation.

As we've seen here in the States, the banks that are hoarding money are not lending.  Rather, they are playing the stock market.  More "wealth-effect" illusion with nothing accomplished along the lines of the real economy

Same story, different Continent.

The monied Japanese will instead know that their money is going to plunge in value and they will try to prop it up for as long as they can in order to buy US and European real assets before the SHTF.  It is already happening.



This falls directly in line with Bass' theory that the Japanese yen will strengthen greatly before it plunges, as real money leaves the economy and is parked in real assets overseas.

This does not end well at all.


Son of Loki's picture

One difference is people actually live in those houses in Japan vs. Ghost Cities of the PRC.



Peterus's picture

Aging is not the cause.

It only becomes the cause when you rob future generations to pay current generation (and of course take commision on this transactions) and there is not enough suckers to pay up. In normal situation people just save some money (not the same as participation in Ponzi retimerment scheme) while they are in good health and working age. In fact without all this massive theft people would actually have their living standard rise with schrinking population. Slower advancment in technology, but less takers for the same resources - and individual families don't need to devote time, energy and money to rise a few kids, but only 1 or 2.

Never One Roach's picture

Long ... diapers and weapons....and crematoriums.

W74's picture

Japan, if things hit the fan there, will ramp up it's military (The almost 70 year old treaty ending WWII be damned) to defend itself from potential threats out of China and N. Korea, and to boost it's GDP, and put a generation of lazy, sex-addicted, video game playing youngsters to work.

The US will look the other way when it happens and not enforce the treaty.  Who will the US have to worry about more in the near/middle term?  China or Japan?  Plus with our "obligations" to protect Tiawan and the Phillipines we'll allow it to happen.

Of course, should Japan go to war with China and win we'll be creating another monster to deal with 50 years down the road (A newly militarized Japan) and the US will then have to contend with a savvy, technological powerhouse with a regionally dominant Navy with a generation of war veterans as the main political bloc.

How will our Army and Navy with their ranks filled by Mexicans (the ones who haven't rebelled and are nominally loyal to the US and not gang-bangers looking to get experience), urban and southern blacks, and dimwitted White Trash be able to compete in a world where technical sophistication and second-by-second military communications and responses are far more important than a large and expensive Army and Navy full of nominal conscripts who would otherwise be on the welfare roles?  Answer: we won't be able to compete, but we'll certainly try to maintain the illusion that we can.

Notarocketscientist's picture

I dunno - maybe we will just watch more Dancing with Stars?

LawsofPhysics's picture

Notice how the euro-zone and the U.S. are getting closer together.  By design folks, all by design.

Eally Ucked's picture

Help!, I'm getting bipolar very fast by looking at all those fake data graphs, every day few hundreds of them, more data, more digits, more potholes, more unemployment, growth, SNAPS, wars, big dick enhacement emails, retail sales growing and dipping, oil cheap and very expensive at the same time, gold is paper, paper is toilette tissue, more democracy or less of it! Al Qeada good in Libya and Syria, bad everywhere else, Japan wants rocks and China too. Can I rent some good appartment in Patagonia?

Itch's picture

They need to start perking up the water supply with testosterone, maybe burn some incense in street lamps, or have gigantic porn screens in the sky pumping out filth 24/7. Or even mandatory Viagra induced shagging, similar to military service, and if you don’t participated, then you are decapitated with a huge samurai dildo. 

BandGap's picture

No, they have to present a threat to the common man that is easily underrstood and one that leads to the loss of some inherent 'right" or "way of life"mto begin the mobilization for war. Read the manual for these types of things.

Itch's picture

So you dont think that samurai dildo's pose a big enough threat to the common man? Each to their own, i suppose.

Super Broccoli's picture

looking at japanese charts, a question comes to my mind : why do we even care about the deficit and the debts ? i mean Japan surely isn't going to ever pay back and it can still raise money from the BoJ ... it's perputeal debt ! And after all who cares ? Let's just do the same idiotic same thing !


If we want to hide the fact BoJ's the only Japanese debt buyer and Fed's the only US-bond buyer we can hide it making it the other way around : the Fed buys Jap's debt "because we believe a recovery in the Japanse economy is to come" and the BoJ buys the US-bonds stating the same reason ...

erm hey ! didn't Japan say it would by eurozone's government bonds this week ? :-)

dark pools of soros's picture

This new normal of destroy currency / juice assets can go on for 5 or 50 years... It is the new method to fleece the working class.

Market crashes are the new mob muscle.. Threats to get what they want, not anything to do with fundamentals

Appl getting shot down while market stays afloat just gives another reason to rise the market further higher when the appl 'turnaround' happens again

This is too good of a siphon for them to end the train early

schadenfreude's picture

Carthasis or Euthansia?

joego1's picture

This will be act two in "To Many Eaters" We are already watching "Europe Eats Their Young"

Lord Of Finance's picture

Sumting wong in Japan ever since the meltdown. They have been acting strange, erratic and radioactive.