Will Japan's "Attempted" Reflation Succeed And Will It Spill Over Into Full-Fledged Currency War?

Tyler Durden's picture

Yesterday we presented a simplistic analysis of why for Japan "This Time Won't Be Different", a preliminary observation so far validated by the just announced Japanese December current account deficit which was not only nearly double the expected 144.2 billion yen, printing at some 264.1 billion yen, but was only the first back-to-back monthly current account deficit since 1985.

In short - at least in the first month of Abe's great reflation attempt, not only did trade post another whopper of a deficit, but so did the broader current account implying that much more Yen weakness will be needed to generate the structural reforms sought by the new Prime Minister.

But perhaps we are wrong and this time Abe will succeed where he, and so many others, have failed before. And, as is now widely understood, perhaps Japan will succeed in finally launching the necessary and sufficient currency war that would be part and parcel of Japans great reflation, as even various G-8 members have recently acknowledged.

The question is will it, and when?

One attempt at an answer comes from the fine folks at Bienville Capital who have compiled the definitive pros and cons presentation on what Japan must do, and how it will play out, at least if all goes according to plan.

What not even this presentation addresses is what happens if Japan is, in the end, successful in reflating, in the process beggaring all its neighbors, radically shifting the economic lay of the globe, and launching full blown currency war - far worse than anything seen to date, including the dark days of the 1930s.

Below are the highlights:

  • Monetary policy in Japan is undergoing a monumental change. For the first time in Japan’s post-bubble era beginning in 1990, it appears policymakers intend to drive real interest rates into negative territory. As a result, we believe the yen could continue to weaken and that Japanese equities could be in the early stages of a powerful rally
  • On October 30, 2012 the Bank of Japan and Ministry of Finance issued a joint statement entitled “Measures Aimed at Overcoming Deflation,” setting the stage for “powerful easing,” including what seems to be an explicit attempt to weaken the yen. On December 16th, 2012, Shinzo Abe was elected Prime Minister with a mandate to end deflation (i.e. to reflate the Japanese economy)
  • Although Japan has struggled with a deflating economy for nearly two decades, the timing of these actions is not random. For a variety of idiosyncratic, macro and geopolitical reasons, the Japanese economy is faltering. Partly as a result of a strong yen, industrial production and business surveys have deteriorated, and the revenues of several national export champions have collapsed
  • Due to negligible growth and deflation, the level of nominal GDP in Japan remains well below previous highs (Slide 4), a dangerous circumstance for an economy carrying the world’s largest sovereign debt burden. As history has proven, debt and deflation cannot coexist
  • In return for failing to reflate the Japanese economy, the Bank of Japan is on the verge of losing its independence. At the behest of Abe, it seems likely the BOJ will confirm a new 2.0% inflation target on January 22nd. In April 2013, the BOJ’s ‘hawkish’ Governor, Masaaki Shirakawa, is set to retire, likely to be replaced with a far more ‘dovish’ candidate (Slide 5)
  • In implementing monetary policy, the Bank of Japan is authorized to buy domestic and foreign assets, including equities and REITs (Slide 6). Achieving the 2% inflation target will prove difficult as domestic deflationary pressures remain. Wages, specifically, are contracting (Slide 7). Hence policy will need to be highly aggressive
  • In recent years, although the BOJ has expanded its balance sheet (Slide 8), it has risen far less than other central banks since the financial crisis began (Slide 9)
  • Regardless of whether the BOJ proves successful in achieving their inflation target, the expectation of aggressive policy can have a meaningful impact on the yen and Japanese equities, which remain at low levels compared to previous highs (Slide 10 & 11). Recently, equities have rallied and the yen has begun to weaken (Slide 12). But on a “real, trade-weighted basis,” the yen could fall another 20% before reaching the levels of 2007
  • To be clear, the intention of the additional policy measures in Japan is to enlist the “portfolio balance channel”—that is, to drive “real” interest rates negative, forcing Japanese savers out of cash and bonds and into riskier assets (i.e. equities). The Federal Reserve has attempted this process twice recently: in 2003 and 2009 (Slide 13), both of which resulted in higher asset prices. By contrast, real interest rates in Japan have remained positive, benefitting bondholders (Slide 14). High real rates also encourages saving over consumption
  • The 2003-2005 analog in Japan is interesting: monetary policy was aggressive, the BOJ’s balance sheet expanded by 25%, the yen weakened by 15% and Japanese equities rallied 125%. Of course this occurred during a period of global easing and reflation. In order to achieve today’s stated goals, the BOJ will need to be far more aggressive. For instance, in order to peg and maintain the Swiss Franc to the Euro at 1.20, the Swiss National Bank has expanded its balance sheet by 100% since August 2011
  • We believe the primary risk to this theme is lack of policy follow-through—that is, policymakers fail to act to the degree they are currently suggesting, as has occurred in the past. We currently believe this risk is minimal given the determined and coordinated communications from policymakers, as well as key upcoming events (e.g. Upper House elections, etc.). However, lack of policy follow-through would invalidate the theme
  • However, on a valuation basis, Japanese equities are relatively cheap (1.2x Price/Book versus 1.5x for other global indices) and yield 2.7%, more than 3x the yield from Japanese government bonds
  • International mutual funds are also currently underweight Japanese equities. Goldman Sachs believes international mutual funds’ allocation to Japan is 4% below benchmark (MSCI EAFE). If portfolio managers feel pressure to “get to benchmark, ” some $60 billion could flow into Japanese equities (in addition to the estimated $20 billion of recent inflows
  • Japan’s debt-to-GDP ratio is above 200%. Therefore, higher interest rates in Japan could be highly destabilizing. Today policymakers are undergoing a delicate balancing act: attempting to increase inflation and inflation expectations so that investors reallocate savings to riskier assets without causing nominal bond yields to rise. We are unsure of whether they can achieve this and continue to expect significant stress in the JGB market at some point. However, at the moment our focus has been to attempt to profit from a weakening yen and rising Japanese equities
  • To be sure, these events have significant implications for the global economy. To weaken the yen, the BOJ needs to buy foreign assets, and given the size of the purchases required, the likely candidates would be US Dollar and Euro-denominated assets. Neither the US, nor Europe prefer to see a meaningful appreciation of their currencies
  • A materially weaker yen also complicates the necessary global rebalancing process: the US and parts of Europe—i.e. current account deficit countries—need to move towards trade balance to achieve sustainable growth (i.e. a weaker USD and euro relative to some peers). By contrast, the surplus countries, notably China, Japan and Germany—the world’s 2nd, 3rd, and 4th largest economies—need to engineer more domestic demand, relying less on exports, or external demand, for growth. A policy-induced shift back towards export-led growth by the surplus countries would only rekindle the global imbalances that erupted in 2008
  • Having virtually exhausted its ability to grow through investment, China is unlikely to sit idle as Japan weakens the yen, stealing external demand in the process
  • Recently, the yen has weakened by nearly 20% versus the Korean won, one of Japan’s primary competitors, threatening Korean exports, which represent 50% of its economy
  • In sum, aggressive actions by the BOJ could escalate into a full-fledged currency war. Investors should be monitoring these events closely

Full presentation:

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economics9698's picture

It will fail spectacularly when the domestic buyers realize the Chinese are buying gold, they are getting 80 basis points on a 10 year, and the inflation rate is 2%.

FreeMktFisherMN's picture

Yep. And there is no 'first-movers advantage to currency wars as was on the previous post, either. Devaluing peoples' savings leads to internal wealth getting sucked out in favor of the precious GSEs. The U.S. had a strong gold-backed currency in our industrial revolution days and we exported more than anybody. Terms of trade are not benefitted by cheaper currency, because things just cost more at home, then. 

disabledvet's picture

but the USA is NOT engaged in "beggar they neighbor." We've lost ten million jobs and a DEMOCRATIC President has said "free trade is a good thing."!!! I would argue STRONGLY that "Japan has its running shoes on" here whilst Europe is just "whistling Dixie." My understanding of the Boeing Dreamliner is that thing is almost "en toto" Made in Japan. If that's the case then as the yen "devalues" (and not merely depreciates) the value of that "vehicle platform" SOARS. That augurs well for more than a mere "industrial recovery." Japan is a POWERFUL industrial economy on a par with the TOTALITY of the euro-zone. China "ain't even close to either" in that regard...and with both the Russians and Chinese "making noise" against Japan there is much the USA can do to reciprocate this valued friendship should it choose to. In short "the value of ALL vehicle platforms made in the USA start to soar" as well. Can't say i'm privy to any "negotiations" but given the reality of Fukushima i'm not sure i have to be. "that's more than a mess." clearly more than an olive branch has been extended here...i fail to see what could possibly be lost by answering it "in kind."

suteibu's picture

Dude....damn.  The US has been beggaring the Yen since the Plaza Accord. Otherwise your comment seems to be just random cheerleading about made up shit.

new game's picture

psst. armed conflict with sides being taken, china sitting by idly-lol.

new game's picture

hey maybe china will melt gold to bullets and fire at will-more lol

these folks need to leave their board rooms and look around.

oh and yea, kyle trade is getting very interesting, dig deep to stay in the game

betcha kyle wishes he could print...

new game's picture

widow maker for many many parties, behind the curtain - no widow makers there.

bobthehorse's picture

Abe's nuts.

But I don't see inflation in Japan.

Deflation.  Deflation.  Deflation.

That's the future.


philipat's picture

German cars are more difficult to sell against the Japanese with a Yen already devalued by 20%. Enter Draghi...

What a fucking joke.

Meanwhile, Bernanke has a problem because his strategy to devalue the Dollar and inflate isn't working with all these other pesky CB's joing the race to debase.

Jack Burton's picture

It is looking more and more like currency war is spreading. Japan went over the top and into battle with their  actions. Britain launched one currency assault and now appear to have no choice but to undergo another devaluation as their economy is triple dipping. Bill Gates recently warned he feared the currency wars could go nuclear meaning they would morf into trade wars.

It looks more and more like Marc Faber was right, "They will print and print and print, then they will go to war".

We see a world with spreading currency war, this will likely go on to trade wars, and just looking around, proxy wars are spreading like in Syria and Libya and Mali. The bigger wars like Israel/ Iran and USA /Syria + Iran look more and more likely. The west is tripping over itself pushing forces into Africa to counter Chinese economic influence. China and Japan are play naval chicken over islands and their relations are sinking fast.

Currency wars, trade war, hot wars all seem in the cards!

disabledvet's picture

you're not buying my Age of Aquarius meandering? More like this: http://www.youtube.com/watch?v=JlSQAZEp3PA

Banksters's picture

Give me a GOD DAMNED data entry credit system.


I'LL CREATE A DYNASTY amongst my friends.   And fuck everyone else.


Sorry, Jon Corizne is still free, and it FUCKING PISSES ME OFF.

Lordflin's picture

My money is on the 'hot war'... although we have the trillion dollar coin in reserve just in case...

new game's picture

print- buy arms and gold ie china

now for some strategy, the real asset...

OpenThePodBayDoorHAL's picture

I think Golem has it right: we already have war, just a different kind:

I wonder if nations, who by this point have painted themselves in to an exit-less corner of having to print to endlessly prop up their banks and achieve short term devaluations of  their currency, have realized that if you can’t spur growth in your home economy then a workable alternative (and a far faster one) is to insinuate your currency in to other people’s economic growth.

If so then the situation evolves again. Nations that have been printing can see that if they can expand the use of their currency –  by making it cheaper to borrow, selling more debt so more people hold IOUs in your currency, getting your currency in to other people’s hands so more people use it to fund their economic activity, –  then your printing and your currency is tied to ever more economic activity, much more than you have at home, and is, by this means, safeguarded from inflation. I wonder if we could consider the Yen Carry -Trade, part of the reason Japan could print all through the  lost decades without inflation? The Japanese economy didn’t have to grow as long as trade utlitizing the Yen did.

Are we entering a world where printing begins to create its own imperative to print more.  The more you print, the more your currency invades other people’s economic activities, the safer your printing is and the more license you have to print yet more.

This, it seems to me, ushers in another side to currency wars. This side is not simply about currency manipulation and devaluation but about Currency Imperialism. Print up cash the way you used to train up soldiers and send those paper and electronic warriors off to conquer foreign lands. The only problem is the one common to all forms of Imperial empire building. Not everyone can expand indefinitely. At some point empires rub against each other and compete for space and influence. If I am even partly correct then wars will be fought over whose currency is used for what, by whom and where. I would suggest two wars, at least, have already been fought, at least in part, over this when the Euro and dollar clashed over what currency oil should be sold in. And I think this might prove to be a useful way of deciphering why new wars will be fought.


kliguy38's picture

Of course it will not fail.....all other sovereigns shall stand by and allow the Japanese to print unabated......for at least a nanosecond......WE ARE ALREADY in a currency war.....they cannot help themselves. They have no choice...without the printing presses the SHTF scenario begins immediately. Once the currency war gets out of control....and it will......then it all gets FUGLY....it will be like boiling a frog for awhile longer so enjoy full shelves at your local grocer........for now......

fonzannoon's picture

Can someone please tell me if I have this right. I can sit here and buy the japanese yen short etf and go long some japanese stocks and I too can fullfill my dream of a meaningless life self funding coke and hookers? It's that easy? Seriously?

Even Jim Rogers made it seem like it is that easy.

AynRandFan's picture

That's what it says. The more surreal this gets, the more i want to do drugs anyway.

GreatUncle's picture


Do drugs first then it will all seem normal why wait and worry?

kliguy38's picture

ABSOLUTELY MAYNARD!!!! Ben said blow and hookers on the house for all wannabe bankers......just be aware to listen to the music because when it stops you better have pulled out and finished your blow because the Grim Reaper is gonna cut off all the blow snortin hangin dicks he sees....

Panafrican Funktron Robot's picture

Just kinda depends on:

1.  What China and Russia decide to do re: military or currency.

2.  What Korea decides to do with their currency.  They can respond even more aggressively in kind, and they are quite a bit more agile in their debasement mechanisms.  

The other thing too about the yen short is that it's priced on a relative basis.  If Benny or Mario decide "fuck it, let's make unlimited printed unlimiteder", that would pretty quickly fuck that trade.

Don't get me wrong, going long EWJ has been a "caveman" trade since Abe got elected, but it's about as momo as LuLu Lemon.  

Yen Cross's picture

 Mrs. Watanabe wants to offshore. The Asian islanders are already fed up with (Abe inflation). Don't fuck with KAMPO!(postal system) Abe you ass clown!

jackes123's picture

just curious, if China drops nukes in major Japan cities, say ,10 cities in 10 hours, what will happen afterwwards? let's face it, Japan is vanished.

fonzannoon's picture

Hawaii vanishes 6 hrs later and then California 7 hrs later.

ersatzteil's picture

And then the fallout clears and there are millions of shovel-ready liquidator job openings for America's unemployed.

New Los Angeles - you didn't build that.

Mine Is Bigger's picture

I think Chinese leaders would rather nuke their own country than to destroy Japan.  There is a good reason why they stash their ill-gotten wealth and family members overseas.

Abbie Normal's picture

What happens afterwards is there will be one billion less Chinese to worry about.

chump666's picture

This is actually quite alarming, China now Russia...http://www.nytimes.com/2013/02/08/world/asia/japan-says-russian-fighter-...

As for the forever trade on Japan equities and short YEN destruction.  Sooner or later Japan's bond market will blow up.  Abe will print, Japan gets hyperinflation as the 'rotation' trade becomes YEN to equities (not bonds, they would have died by that point) and we will witness the first country to follow the 'central bank/goverment induced inflation to war scenario'

Yen Cross's picture

 Thanks chump. Hey did you catch that pop off top on the DXY through 80 earlier? One hour chart. That bad boy poped up through 2 levels in the low 80's and never looked back. The 4 hour (sar) chart has some running room.

 It's getting ugly for risk!

chump666's picture

Yes, now funny thing is while the YEN is sent south, the DXY is bid.  What the DXY is showing (and yields/credit) is that our all in stock rally is 100% Europa driven.  Liquidity is tightening.  Yen, I tell you man...there is a juicy short on this, i know, i know...central banks.  But, damn, this thing blows...hedge funds go short, HFTs go bonkers etc.  You can come chill with me, drink some whiskey and eat sushi...I love sushi, actually prefer it with Vodka, polish vodka

jackes123's picture

this is good.

I hope to see Russia and China crush Jap.

AynRandFan's picture

Obviously, the Bernanke Plan will be implemented more and more vigorously everywhere because we are well past the point of no return. Just as obviously, the more effort put into artificial stimulus, the fewer people will believe it will work. The waiting game for natural juices of capitalism to take over is a cruel joke as we are schooled 24x7 how immoral it is to conduct business for profit. Let's face it, the era of the entrepreneur will be buried under a mountain of re-education propaganda while the once-proud tradition of individual achievement is merged into the great collective. By the way, stop saying "I built that."

DonutBoy's picture

I think this is good as far as it goes, but its missing real point.  Reflating the economy and leveling the playing field for exports are the pretty words.  The reality is decreasing the real debt.  The thing they must do is avoid nominal default.  At this they can suceed whether the real economic output advances or declines.  Since they are now net importers, they can get inflation without reflating their economy.  Oil priced in yen goes higher.  JGB debt denominated in barrels of oil goes lower.  That WILL happen.  Nothing can stop them and they have no other choice.

Dareconomics's picture

The Bank of Japan has lost control of the yen. Then weakening and the imminent inflation are a direct consequence of Japan's dire economic and fiscal position:



GreatUncle's picture

Up until 2008 Japan was doing alright because the rest of the world was functioning of a sort masking their problem.

Scince 2008, natural disasters and all with nowhere in the world able to support Japan's financial position it has been forced to act. Wether it will achieve anything other than blowing other nations debt bombs up we shall have to wait and see.

Even if they intentionally manage to dentonate another countries debt pile through their stimulus as soon as that has settled the financial pressure will immediately go back on Japan again.

In the end you can't win that the action might be considered vindicitive.


yogibear's picture

Go ahead Japan and commit Seppuku.

Bernanke, Evans, Dudley and Yellen will help turn the knife.

Those fed members are chicken, they will leave the country before the US blows itself up with printing.


DUNTHAT's picture

Don't believe the South Koreans will stand idily by and let their exporting powerhouse get taken down by the weak Yen.



besnook's picture

japan did the world bankers a big favor by dropping the currency atomic bomb. there is huge room to print now without anyone but the salarymen of the world having to pay for it, a free lunch for the bankster class on the backs of the little people. it is a good thing the people of the usa are so stupid. they might riot if they really knew what was going on. it is like someone slipped them a date rape drug. the eurozone is about to blow up because the people are tired of anal sex without any k-y. they will need to be distracted by war. mali isn't enough. the end game is nigh. iran here we come. the great reset is just a bombing away. nothing like a big war to wash the debts of the world away.

new game's picture

nice series of thoughts; nothing to add as i see the same.

wondering where one hides-costa rico? geutamala, or panama????

dadichris's picture

they can try all they want but the race to the bottom will be won by one of the round-eye nations >_<