There is a stark contrast between the deterioration of the political and economic environment in Japan and the relative strength of the yen. The mystery is resolved by recognizing that the drivers of the yen’s exchange rate has little to do with the macro-fundamentals in Japan and more to do with the general investment climate and interest rate differentials.
Japan: Slip Sliding Away
Make no mistake about it, although Japan did not experience the US real estate implosion or Europe’s sovereign and banking crisis, its economic crisis is just as profound. And, as appears to be the case in America and Europe, Japan’s political institutions or politicians may not be up to the task.
Japan has had six prime minister in the past six years. The list of suitable candidates may be so limited, that tit may begin recycling former prime ministers. The current and increasingly unpopular prime minister appears to have consented to hold elections in which his Democrat Party of Japan is likely to lose mightily to the former ruling, and now main opposition party, the Liberal Democrats. The leader of the LDP is Shinzo Abe who was prime minister from Sept 2006-Sept 2007.
Polls suggest the DPJ will likely lose more than half their 240 seats in an election, which could be held in mid-to-late December. It would require the dissolution of the lower house of parliament in the next week or so. Current Prime Minister Noda has been cagey about when he will call the election. The LDP supported his controversial retail sales tax hike on the condition that he would call elections.
Noda has not done so and wants to parliament to accomplish three things: 1) approve a deficit financing bill, ideally covering a few years; 2) complete the electoral reform; and 3) agree to a framework for social security reform. While the first goal is likely to achieve as negotiations are reportedly underway, the other two look decidedly less likely.
Before the US election, there was some discussion of Federal Reserve Chairman Bernanke’s tenure. Some thought if Romney was elected Bernanke would step down. We never believed that and thought there is good reason why the president and Fed chairman terms are not concurrent. We have shared the sense that we have picked up that there is may be an informal term limit for the chairman in the post-Greenspan era.
We do expect a new Federal Reserve chairman in 2014. However, that means that the focus on personal changes at central banks should look elsewhere. Bernanke will likely be in office after BOJ Governor Shirakwa’s term ends (March 2013) Bernanke will also likely last beyond PBOC Governor Zhou and BOE Governor King,whose terms end next year.
The new government in Japan will inherit the first current account deficit in more than 30 years. Between deflation and contraction, the economy the LDP will take stewardship has shrunk to 1993 levels. In both the second and third quarter, consumer spending fell. Foreign demand is poor and exports to the US, Europe and Asia are off 10%. With weak demand, capex is also a contracting.
We are often told that countries that print their own currencies are at a distinct advantage to countries that cannot. Hence the argument goes the UK is fortunate for not joining monetary union and that Greece (or other peripheral countries) would be better served by dropping out and reintroducing their own currency. Tell it to the Japanese. The strength of the yen may not be the most significant problem Japan faces, but it makes Japan’s problems more intractable.