JAPANESE YEN

Japan is the second largest developed economy in the world. Yet its size doesn’t guarantee
a successful economy. To understand Japan today, one has to have a sense of where
the Japanese economy has come from.
In 1989, the Nikkei 225 Index, which is a price-weighted index of the top 225 stocks
on the Tokyo exchange, peaked around 39,000. In 1990, the Nikkei Index fell by 39 percent,
and in March 2007, it was at the 17,400 mark, still quite a way from the highs of the
previous era. The “bubble” (1987–1991) in Japan had broken. The “bubble” was characterized
by extremes in consumption of luxury cars, expensive food, outlandish art auction prices, and surges in sales of luxury brand bags and jewelry. The Nikkei had
tripled in price in the 45 months prior to its peak. Also, metropolitan land prices tripled
between 1985 and 1989. Finally, there was a significant increase in borrowing to finance
home purchases (Atsushi Maki, “Changes in Japanese Household Consumption and Saving
Behavior before, during, and after the Bubble Era: Empirical Analysis Using NSFIE
Micro-data Sets,” Japan and the World Economy, January 2006).
Then Japan experienced what has been called “The Lost Decade.” Between 1995 and
2002, the average annual GDP growth rate was an anemic 1.2 percent. Compare this to
the same period growth rate of other nations, shown in Table 7.3.
The Japanese stagnation had many causes, but a major contributor was the Japanese
consumer. Studies (e.g., Charles Horioka, “The Causes of Japan’s Lost Decade: The
Role of Household Consumption, Japan and the World Economy, Vol. 18, 2006) have
shown that in Japan, what could go wrong in consumption did. Household disposable
income declined, household wealth declined, and, coupled with uncertainty about the
future, the result was low confidence in prospects of strong growth. Once the forex
trader appreciates what the era of stagnation was like in Japan, he or she will have
a greater understanding of why Japan today is still not on firm footing of renewed
growth.
For example, household disposable income had a growth rate of only 0.98 percent
for 1991 through 2003 compared to 3.32 percent for 1980 through 1991. Household wealth
declined by an average 0.39 percent. Interestingly enough, there is data showing that the
proportion of people saving for old age rose from 50.5 percent in 1991 to 60.4 percent in
1995, demonstrating great fear of the future and lack of confidence in the economy. The
data from Japan underscores the importance of consumer confidence. When confidence
is low regarding one’s country, consumers tend to save much more. This makes it difficult
to stimulate growth through traditional monetary measures such as lowering interest
rates. Another important characteristic was that prices were actually in deflationary
mode, and when prices keep falling there is little incentive for consumers to purchase
since they expect cheaper prices.

Few of today’s forex traders remember this period of time in Japan, even though
it was less than a decade ago. It was before the emergence of the retail forex market.
But the era of stagnation also holds clues as to whether Japan will experience robust,
uncertain growth or retreat again into stagnation. Much will depend on the interest rate
decisions of the Bank of Japan and business and consumer confidence surveys because
the core cause of stagnation was lack of consumer confidence and spending. Therefore,
the core of recovery will be a recovery in consumer spending.
But it is not easy to stimulate the Japanese consumer. This means that the forex
trader should carefully watch consumer confidence and inflation data coming out of
Japan for clues as to whether Japan is overcoming deflationary fears. One such clue occurred
in March 2007 when, for the first time in 16 years, Japanese land prices showed an
increase. Other clues will be necessary before the Japanese inflation rate moves beyond
its current 0.0 percent rate. Also important is export data on Japan. Stimulating exports
becomes a critical factor in determining the ability of the Japanese economy to grow.
Any significant strengthening of the Japanese yen, particularly against the dollar or the
euro, could threaten Japan’s export growth. However, any extreme level of weakening
of the yen would help exports. But remember that too weak a yen against, for example,
the euro may help Japanese exports but would undermine European exports. The forex
trader should note that where there are beneficiaries to a currency direction, there are
also losers. The Japanese finally increased interest rates to 0.50 percent as part of its
central bank’s policy of encouraging inflation. But the interest rate differential between
Japan and other nations is still quite steep. Even if the Bank of Japan increases rates to
0.75, if other central banks also increase their rates (the central bank of New Zealand increased
rates to 8.0 in June 2007), the effect of this differential may encourage continued
outflows of capital from borrowing yen to invest in kiwi and other currencies (see the
next section on the carry trade).
This uncertainty in the Japanese economy creates a great deal of increased ranging
behavior in the currency. Traders of the yen should almost always expect the unexpected
because economic news from Japan has a built-in greater potential to surprise us.
Also important to consider is the growing impact of China on the Japanese prospects for
growth. China has now surpassed the United States as Japan’s largest trading partner. As
a result, if the yen were to move toward a strengthening, Japan’s exports could be hurt. A
weak yen, in contrast, stimulates Japanese export growth. Export growth data therefore
becomes very important in affecting sentiment toward the yen.
With regard to Japan, perhaps the best word to describe current conditions is uncertain.
The uncertainty whether the Japanese consumer economy is strong enough to
grow, combined with the uncertainty of whether Japanese interest rates will rise, dominates
trading of the yen. The complexities facing the Japanese economy also involve
aging workforce and potential shortages in labor. All these factors make trading the yen
more challenging than the other currency pairs.




By ABE COFNAS