By John Mauldin


All Japan, All the Time

Japan grew at a 3.5% annual pace last quarter, the fastest pace in a very long time. Of course, government officials see this development as vindication of their new policies and will no doubt decide that even more of the same will be needed in the future.

Retail sales in Japan are soaring as a “wealth shock” electrifies the economy. The Nikkei index has risen 70% since November, with foreign hedge funds among the first to jump on the bandwagon. The chart below provides some perspective on that rise. I can see several similar moves in the past 20 years. If this were a one-year rather than a 30-year chart, would everyone be so eager? I’m not saying that the move isn’t real. A lot of money has been made, at least on paper.

The weaker yen is already delivering a powerful punch, accounting for almost half the growth in the recent quarter. The currency has dropped 30% against the dollar and against China’s yuan since August, and 37% against the euro. This causes Ambrose Evans-Pritchard over in London to worry:

The yen-slide – or “Enyasu” – has raised concerns that Japan is exporting deflation through a “beggar-thy-neighbour” push for export share, a claim rejected by Tokyo.

Stephanie Kretz from Lombard Odier said the falling yen looks like a replay of the mid-1990s before the onset of the East Asian crisis, when external funding dried up in a “sudden stop”.

It poses a direct threat to Malaysia, Vietnam, Thailand, Korea and others with a high trade gearing, as well as for China, though foreign debts are lower this time. She warned that the trade surpluses of these countries could evaporate, “silently planting the seeds for the next Asian crisis down the road”.

Albert Edwards from Societe General said “Enyasu” may be the catalyst that pops China’s credit bubble. He warns that loss of exchange competitiveness after years of soaring wages leaves China vulnerable to a deflationary monetary squeeze and should ring alarm bells. “This closely echoes the situation in the run-up to the 1997 Asian currency crisis.” (The Telegraph)

Currency manipulation is against the G7 and World Trade club rules. Japan, they contend, is merely engaged in a domestic policy move to try to stop deflation and kick-start the economy. So anything that happens on the currency front is a complete coincidence.

Except that it isn’t.

Japan has been in a deflationary slump for over two decades. Nominal GDP has not grown. Government debt-to-GDP is now over 240%. Interest rates have been stuck at the zero bound. There has been no control of the fiscal deficit. The trade deficit has been rising. All this led me to start calling Japan “a bug in search of a windshield” a few years ago.

Prime Minister Abe has committed to a “three-arrow” approach to solve Japan’s problem. The three arrows in his quiver are more-credible fiscal plans, aggressive monetary easing, and a growth strategy based on structural reform. The monetary easing is the easy part. Essentially, the Bank of Japan is engaging in almost as much quantitative easing as the US Federal Reserve but in a country 1/3 the size of the US.

And while the headline number is rather startling, the Bank of Japan has a long way to go to catch up in the QE department. The UK and US are WAY ahead of Japan, as this chart from Capital Economics makes clear. (For those reading in black and white, the line that just reaches 300 in 2015 is Japan’s current policy projection.)

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