International | Oct 26 2007
By Greg Peel
If you’re a big, successful Japanese company like Toyota, then you’re presently doing rather nicely thank you. But if you’re just a guy in Tokyo with a small business trying to make ends meet, it’s a continuing daily struggle. Things started looking a bit rosier around the beginning of 2007, but the credit crunch appears to have put paid to that.
The Japanese economy has been in the doldrums for over a decade, ever since the post-war economic miracle ended in a big bursting bubble. China pay heed. While this is sufficiently frustrating in itself for businesses and monetary officials alike, the frustration is further piqued by the great yen carry trade. Whether it likes it or not, Japan has become lender to the world – to everyone from hedge funds to Tokyo housewives – and subsequently helped to stoke the fires of global excess liquidity.
The irony now is that excess global liquidity was required for the debt security market to get itself into the state it has, and the credit crunch has put the brakes on a Japanese economy which was just showing fledgling signs of recovery. Japan, too, bought subprime debt.
Authorities at the Bank of Japan have been champing at the bit to raise interest rates. They have had their fingers poised over the button for months now, looking for the first signs of inflation or a pick up in GDP. The Japanese interest rate has only squeaked up to 0.5% from years at zero (or less). This seems incredulous when one of Japan’s great suppliers – Australia – is potentially looking at 7% soon.
Japan has not only lost face by being an almost laughably cheap source of funds, it is also very worried about the legendary Mrs Watanabe.
Before hedge funds got into full swing of borrowing in yen and investing in high-yield asset-backed securities, Japanese mums & dads were seeking any means to escape from the wealth-destroying effects of negative real interest rates. This led to the popular investment in so-called Uridashi bonds, as one example, where attractive interest rates in New Zealand made government bonds a popular destination for Japanese savings. As the Australian economy has surged on the back of China, Australia has also moved into a higher interest rate phase and attracted significant attention as another source of yen carry trading. That’s why the Aussie has reached over US$0.91.
But as the gap between Japanese and global interest rates began to widen, so did the opportunity to achieve more than just wealth protection become apparent to bored Japanese housewives who, as culture dictates, were sitting around at home with way too much time on their hands. One day a particular Mrs Watanabe learnt how to profit from playing currencies over the internet, and told all her friends. If Chinese housewives have suddenly become rampant stock speculators overnight, Mrs Watanabe and co have become addicted forex punters.
This does not please the government. There have been two carry trade unwinding scares in 2007 – the first after the Shanghai Surprise in February, and the second more recently at the depth of the credit crisis. Each time Mrs Watanabe and her cohorts have faced the potential of losing all their hard-earned savings, but each time they have pulled back from the brink. One day they won’t be so lucky.
One way to begin crimping currency speculation is for the BoJ to actually raise the cost of funds in Japan. This would not necessarily spark a panicked unwinding of the carry trade, but it may fire a disciplinary warning shot. Not just to Mrs Watanabe, but to all those good-for-nothing hedge fund managers who flaunt their winnings by, for example, naming their newly acquired yachts “Positive Carry”. If Japan could move into an extended but controlled tightening phase, then it’s possible that an extended but controlled reduction in excess liquidity could follow.
But alas, the BoJ can’t just put up rates without a reason. That reason has to be some sign of price and wage inflation, and some sign of economic strength. Until such are apparent, an interest rate rise would only serve to kick Japanese business while it is down.
In April, Westpac economists put out a paper suggesting the signs were bright in Japan. GDP growth was running at 2.5%, up from 2.1% in JPY2006, and global growth forecasts were on the move up. Input prices to Japan’s massive manufacturing sector were rising rapidly, and inflation had shown no signs of its seasonal slowdown. The economists had August or September pencilled in as the time the BoJ would make its next move.
It wasn’t to be. As the credit crisis across the globe began to play out, the first signs of which really came long before July, Japanese growth slowed. Japan has now suffered eight consecutive months of declining consumer prices. Exports to the US have slowed, corporate earnings from all but a few global leaders have disappointed, and – just to top things off – expectations are now for slowing global economic growth.
Westpac suggests that a whole generation of analysts have now grown up with a bearish stance on Japan. As the excitement began to fizzle, it was just as easy to slip back into default mode. Japanese authorities were sure that years of easy money must eventually create internal imbalances. But even legendary Tokyo real estate has now returned to the bad old days. As credit dried up, construction orders were down 14.2% in August.
Westpac notes that bigger Japanese corporations are doing okay, but profit share has not yet translated into higher wages. The trend is still in a positive direction, but the credit crunch has knocked the Japanese economy down the snake after so many ladders. It will happen, says Westpac, but it will take a bit longer. The economists are forecasting a 25 basis point rise to now occur in February, with another to perhaps follow in September.
In the meantime, the Aussie has a green light. Provided there are no more scares on the credit market front.