Japan Logs Annual Trade Deficit in Calendar 2011

On the back of bad numbers for Nov (see Japan Nov Trade Deficit Worsens - Usd/Jpy to Turn the Corner Soon) Japan has logged another negative surprise for Dec, as announced on The Ministry of Finance website today. This makes the first annual trade deficit in 30 years. The income earned on foreign exchange reserves will likely partially offset that but there is no doubt that Japan's fiscal and current account position is only getting worse. Once the market starts pricing that in, we would expect an upside breakout of Usd/Jpy with an intermediate target in 85.00 area.

(For more on Japan's fiscal situation see Japan's Budget Mess. This WhatIf post is from about month ago but the analysis is still valid.)

The Price of Credibility or Why Hildebrand Quit

The head of the Swiss National Bank Philipp Hildebrand quit his post over a USD 500,000 currency trade executed by his wife without his knowledge (see Bloomberg article). She sold CHF and bought USD just before the SNB floored the EURCHF rate at 1.20 thus profiting around  USD 50,000. It is quite clear that the trade was executed without his knowledge. Still the ethical question would have remained and could have endangered the central bank's credibility which is its most valuable asset. With credibility weakened, the Euro peg may have come under pressure by speculators and a good policy may have been ruined. The Swiss economy needs the reprieve from a constantly appreciating currency and so the objective was worthwhile. (Incidentally Japan could also benefit from a similar exchange rate regime - for that refer to a previous WhatIf post.)

What if 2012 is the Year of the Samurai?

Forget the dragon, cards may be stacking up for Japan to outperform significantly in 2012. The Nikkei was down 17% in 2011 and in fact after peaking just over 20 years ago it is currently trading at around 20% of that all-time high (true, the component stocks and weights have changed so this is not an exact comparison). In fact for the majority of currently active investors and fund managers simply ignoring Japan has been a very successful strategy for most of their careers.

But lets take a careful look. Japan has a smoothly functioning, possibly overly harmonious, society with amazing infrastructure and a highly educated and motivated labor force. The quick recovery from the recent tsunami and nuclear disaster was no mean feat. When power shortages were looming in the summer, a modest amount of moral suasion by the government was enough for businesses and consumers to reduce consumption and mostly avoid blackouts. Japan, Inc. is alive and well.

And on a global scale the alternatives are disappearing fast. In terms of equities, US is unlikely to do anything spectacular, Europe is probably setting up for a recession, as for the BRICs its definitely time to handle with extreme care. Except for Treasury's, government bonds can be quite painful and even Gold is no longer the safe haven of years past. It is by no means a certainty, but the year of the samurai may be upon us.

Japan's Budget Mess

It is sometimes hard to make heads or tails of the political bickering in Japan's parliament, but matters look like they are getting serious. And seriously against prime minister Noda's intentions to raise consumption tax. A few lawmakers have already left his party (the DPJ) in protest against the tax hikes under consideration. At the same time the government's fiscal position is only getting worse, with a record 49% of next year's budget to be financed by bond issuance. Clearly raising taxes would hurt the already stagnant economy, so what can be done?

In some sense Japan has a problem that many countries wold love to have - strong currency and no inflation. A central bank can can always print more of its own currency - the constraints are only that this makes it weaker against other currencies and stokes inflation. But for Japan both of those in moderation are what it needs. So the BOJ should follow the Swiss Central Bank and weaken the yen, which should give a boost to the economy and automatically increase tax revenues.

Japan Nov Trade Deficit Worsens - Usd/Jpy to Turn the Corner Soon

The market is ignoring this fact, but Japan's trade deficit in November was a record JPY 685bn according to statistics published yesterday on Ministry of Finance website. If the trend continues, Japan will find itself in the twin-deficit predicament of the US. Just as a reminder Japan's fiscal position is among the worst in the developed world, with Debt/GDP of close to 200% (which is worse than troubled Italy). Most of the government debt is held domestically, so it is unlikely to be under pressure, but the currency should definitely start weakening. In fact the last time the Bank of Japan intervened to sell the yen when the FX rate broke 76.00 on Oct 31, contrary to popular expectations, the market did not reverse most of the move and has only briefly broken 77.00 since. I would be a buyer of Usd / Jpy around 78.00 with an initial target of 92.50