Japan as a safe haven
The outlet for all financial imbalances is ultimately the currency. At the same time, that is also a big risk for a currency union like the Eurozone. Mutual imbalances have to be solved differently, which amounts to saying that we should all be like Germany, the Germanization of Europe, something that has come closer with the new Ostpolitik. But this aside. Countries with a lot of debt and their own currency, including even Japan, can always pay off their debt in full. The big question is only what the currency will be worth then.
Currently, the yen is undervalued on a purchasing power parity basis, and in recent months the currency has come under further pressure (especially against the US dollar). This is primarily due to rising commodity prices, which means that Japan now has a widening trade deficit. The country imports 80 percent of all its energy needs and otherwise has hardly any raw materials at its disposal. Then there are the increasing differences in monetary policy. This has caused the difference in interest rates compared to the United States to widen. Where the Federal Reserve has begun to raise interest rates, Kuroda of the Bank of Japan indicates that the central bank will respond only to inflation and not to the currency. And the difference in inflation between the U.S. (7.9 percent) and Japan (1.3 percent) is far greater than the interest rate differential. Japan is the only country where there is actual yield curve targeting, and it works so well that the central bank actually hardly has to buy any more bonds.
Policymakers in Japan have long steered toward a weak yen. After all, that’s good for exporting businesses. It does raise the cost of goods that must be imported, but the associated inflation is a nice bonus in a country that has struggled with deflation for decades. The policy of weakening the yen has allowed the country to build up large foreign exchange reserves. More than 90 percent of Japan’s national debt is held by the Japanese. Moreover, the problem is not even so much the debt as the fact that the country did not grow for decades. There was such growth per capita, but due to the aging population, labor force is shrinking. Debt is usually expressed as a percentage of GDP. In Japan, it stands at about 250 percent. Adjusted for the high foreign exchange reserves of $1.4 trillion (partly due to the trade surplus and partly to targeted policies to weaken the yen) and the fact that the economy has not grown on balance since 1990 (that of the United States more than tripled in the same period), that debt percentage can be nuanced. Also, the Japanese are rich because the tax system in Japan is more similar to the United States, but the government on the spending side is more like a European welfare state. So the national debt problem is solvable, but because more than half of the national debt is now in the hands of the central bank (pocket-to-card) it is actually a non-problem.
Because Japanese savers are rich but cannot make a return in yen, Japanese investors (mainly women, because in Japan women manage the family wealth) have been active in the international markets for years. The money is deposited in higher-yielding currencies, even with leverage, and combined with a weak yen, this produces excellent returns. The archetypal investing Mrs. Watanabe actually runs only one risk, and that is when there is a crisis in the world. Then everyone wants to say goodbye to overly risky positions with leverage, and Mrs. Watanabe also flees back into the yen. This ensures that the Japanese yen could also play the role of refuge alongside the United States and Switzerland.
In the past, the financial stress this year would have caused the yen to strengthen, but the trade deficit and monetary policy divergence have actually weakened the yen against the dollar. It is possible that the yen has also fallen victim to the use of the dollar and euro as a weapon in the fight against Russia. Japan has neatly complied with this, and the Russian central bank cannot access its yen-denominated assets either. By also using the yen as a weapon, the Russians, and with them the Arabs and Chinese, suddenly have less need for the yen. They would rather choose the renminbi, for example. Mrs. Watanabe is now speculating on a recovery of the yen. That in itself is not so strange because the inflation differentials with the United States will narrow for the rest of the year and a hint from the Bank of Japan that policy will be tightened is enough to set the yen in motion. Then the structural undervaluation of the yen could well turn into a premium.
Japanese companies are better able than before to pass on higher costs to customers. The likelihood is increasing that inflation in Japan will finally exceed 2 percent. Japanese companies are also no longer as dependent on a weak yen, as much production has been outsourced to various countries in Asia. The need for a cheap currency is no longer there. In Japan, more than in other markets, it pays to invest actively. In the past decades, it was relatively simple; those who did not invest in Japanese financials achieved an outperformance. It remains to be seen whether this will still be the case when inflation structurally exceeds 2 percent. Furthermore, after the double bubble of 1990, a distinction was gradually made between the old Japan and the new Japan. Japanese are incredibly good at improving an existing product. Unfortunately, much of the added value lies “out of the box”. This is precisely what determines the success of Silicon Valley. That’s where anything but perfect products come from, but they are innovative and have great success. These days the quality from the valley is, fortunately, better, but I have cursed Microsoft several times in the past because of the blue screen that indicated that the system had died, one of the reasons that this text is typed on a Mac.
The Japanese stock market is virtually unchanged in yen terms this year, the return is depressed by the yen. The valuation of Japanese stocks is still extremely attractive. Companies have no debt on balance. In the past, Japan’s economy was considered a “warrant on the world economy” because of its high operating leverage, which meant that the Japanese stock market performed particularly well when global economic growth picked up more strongly than expected. This is now not the case, but Japanese companies are actually profiting much more from structural trends such as the energy transition, circular economy, and even deglobalization, because production in Japan is seen as much safer than in, say, China, Taiwan, or even South Korea.
