There Will be No JPY Black Swan

Everyone is talking about The Yen's Looming Day of Reckoning by Andy Xie in which he spells gloom and doom about Japan and the yen. Japan's economy has indeed been trapped in a prolonged period of sub-trend growth and deflation. The strong yen makes things worse by reducing the competitiveness of the country's exporters.

But why a catastrophic collapse? In late Dec in Japan Nov Trade Deficit Worsens - Usd/Jpy to Turn the Corner Soon we thought the government or the BOJ should take steps to weaken the yen, which would impact positively Japan's economy and its exporters, which in turn can jump-start an outperformance of

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