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Monday, February 02, 2009


the crisis in japan

via naked capitalism, the comments of frank veneroso on what is transpiring in japan, a massive exporter and trade surplus nation which is seeing its currency -- long the preferred basis of carry trading worldwide -- strengthened beyond all expectation by the unwinding of those trades (and possible more, as veneroso notes).

I have been writing about an Asian black hole for almost two months now. I have been crying from the rooftops about an emerging depression in Japan. It has been as though a neutron bomb had gone off in the world. There was no one who seemed to notice, no one who seemed to listen.

Every week it gets worse and worse and worse. Today it was Japan....

THERE HAS NEVER BEEN DATA THIS BAD FOR ANY MAJOR ECONOMY – EVEN IN THE GREAT DEPRESSION. December industrial production came in down 9.6%, worse than the METI forecast. It is now down almost 21% year over year. METI forecasts a further 4.7% decline in February. The inventory to production ratio soared again. Maybe METI will be correct.

If it is, Japan industrial production will have fallen 28% (non annualized) in four months. It will have fallen by a third in about a year. Nothing in the history of major nations compares. A 28% decline in four months would be more than half of the entire decline in U.S. industrial production over the 3 years and nine months of the U.S. Great Depression.

It would be a greater decline in four months than in any 12 month period in the Great Depression in the U.S. We are literally looking at the unimaginable.


When bubblized markets go from a mere speculative casino to a casino in which pivotal players are driven only by the pursuit of short-run fee income by hook or by crook, you can get a more willful proliferation of “false” prices and an even worse misallocation of resources.

This is what has happened over the last ten years. The result is what economic theory says it should be: today’s global financial, economic, and social catastrophe. The ruling maxim in such a regime seems to be that market participants will push prices to the point where they do the maximum financial, economic and social damage. I believe that, despite the massive losses to market participants that such behavior has now brought them, their behavior has not changed. Half a generation is enough to breed a cohort among market participants that knows of no other way. This cohort has been hurt and has had its wings clipped, but the markets have become commensurately less liquid. This cohort still runs the show.

Let us now apply this to the Japanese yen. According to the most recent economic data the land of the rising sun apparently risks falling off the face of the earth. Nonetheless, the Japanese yen soars. We hear the ludicrous mantra from all the investment banks and all of their speculator clients that the yen is a safe haven amidst the global chaos.

To my mind the real reason why the yen soars is because it soars. Except for a brief interlude in the mid 1990s the Japanese yen has been bounded on the upside by a ROUND NUMBER – 100 YEN TO THE DOLLAR. It bumped against the ceiling time and again. In recent months the unwinding of massive yen financed carry trades caused a powerful, though transitory, impetus on the part of yen debtors to panic purchase yen. This impetus broke the yen through its magic barrier of 100. Since everyone now ignores fundamentals and only looks at the witchcraft of charts and technical tools they now all have the next technical objective of 79 yen to the dollar on the brain. That was the spike high in the yen in that brief mid 1990s foray above the great ROUND NUMBER of 100. In my judgment it is this chart objective on the brain that explains yen strength today now that most of the panic buying by yen carry traders has abated.

The yen is strengthening massively against currencies all over. On a trade weighted basis, it is by far the strongest currency on the planet. There are long lags between changes in currencies, exchange rates and trade. The recent take off in the yen is not yet fully reflected in Japanese exports. The lags are too long. The weakness we are seeing in Japanese exports today is in large part derived from aggregate demand weakness from its trading partners. It is the result of an earlier appreciation in the yen for perhaps 120 yen to the dollar to 110 to the dollar or 100 to the dollar. And perhaps, most importantly, it is the result of a secular trend in which its lower wage neighbors in Asia are making inroads – big inroads – into the global markets which it has traditionally dominated as an exporter.

When the long lags between the yen exchange rate change and trade and industrial production fully run their course the land of the rising sun may fall off the face of the earth. And with it will fall all the market participants who refuse to look at fundamentals and chase chart witchcraft and ephemeral market dynamics who have been the big bulls engineering that yen exchange rate that will maximally undermine the markets, economy, and social fabric of Japan.

the ongoing spectacular collapse of japan is a result of the confluence of strengthening currency and an export-based model amid a nascent global depression. they are likely to be one of the great economic sufferers this go-round, even if their financial system is largely unimpaired.

but, as an example on china's doorstep, good luck convincing china of the desirability of stregthening the renminbi.

UPDATE: more from ft alphaville, including comments by peter tasker from his note, "breaking the double suicide pact".

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Japan has a lot going for it, particularly in the short-to-mid-term.

In the long term, Japan is demographically weak and needs more Japanese babies, but that's the long term.

In the short-to-mid-term, Japan controls a huge number of industrial trade secrets. These may not be enough to save its population from starvation and misery, but they can guarantee that the oligarchs of Japan won't lose their world leadership position any time soon.

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scs, perhaps you'd agree with a lot of what tasker says -- he admonishes the japanese government for its fiscal and monetary "tightening bias" since the mid-1990s, which has (as is also so in other current-account-surplus countries like china, south korea, and even germany) worked to suppress domestic consumption by keeping its currency too cheap.

the fiscal hawks have seen tax revenue decline relentlessly as deflation downsized the domestic economy, ensuring deficits even while reducing government outlays in spite of the most rapidly ageing society on earth. tasker believes the LDP hawks, in doing so, have never really made a serious enough effort at reflating and trying to get out of the deflationary trap. instead they have relied on the health of their export markets and an undervalued yen to keep business activity up without a properly prospering domestic population. with this macro policy now "game over", his advice is for japan to finally rebalance its economy in favor of its domestic market. tasker thinks the japanese gov't (unlike the US and UK) have massive headroom for further stimulative deficit spending, being a massive net savings and massively positive NIIP society -- they require no external financing, and interest paid by the gov't amounts to a straight cash infusion to the japanese private sector.

but the context of his analysis is really quite positive for japan's longer-term outlook. in spite of its demographics, he calls the banking system "underloaned", and emphasizes the latent demand for housing and other consumer needs resulting from years of low domestic consumptionand high savings. was the deflationary trap broken, japan could (in tasker's implication) see a domestic consumer renaissance from a starting point of strong household balance sheets. closing para:

Of course it may turn out that the challenge is too steep and 3% nominal growth is not achievable in today’s economic landscape. Even so there is no harm trying. Japan is unusual amongst the OECD countries in having the resources (the savings), the mechanism (a functioning banking system), and the safety valve (a strong currency) to make the attempt virtually risk-free.

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