Japan's Economic Miracles: Next One Coming Soon?

The world’s second largest economy has been rocked by the global recession. Japan, once revered as a global economic titan, has been unable to ignite its economy’s flame to break the cycle of a deflating economy.

This island nation has a reputation for producing miraculous economic growth during in the 1960s, 1970s, and 1980s. Falling prey to a series of market dislocations, such as the real estate market bubble in the 1990s, the tech crash in 2000 and recently the global recession that is currently is place, deflation has over come this great nation, with a current GDP at -8.8% and CPI (YoY) at -1.1%. This net exporter also has to balance a delicate relationship involving Japan’s currency, the yen, with other major currencies, especially the US dollar.

Since the United States is Japan’s largest export partner, accounting for approximately 20% of Japan exports, it is in Japan's self interest to have a weak yen policy vs. the US dollar. If yen values appreciate against currencies such as the dollar, it will result in higher prices for imported Japanese goods in the US.

On the other side of the coin, if the yen values depreciate versus the US dollar, it will result in lower priced imported Japanese goods in the US. The key to Japan’s economic recovery is strong global demand for products, especially from the US.

Recently, the yen fell 1.8% against the US dollar due to inspired optimism that US corporate earnings would continue to be positive for the remainder of the month. Several market movers, such as Apple (AAPL), Pepsi (PEP), Wells Fargo (WFC), American Express (AXP) and Ford (F) are due to do release better then expected earning reports, which will help to mediate the battle that is being waged by the bulls and bears over market direction.

2008 delivered a critical blow to Japan’s Nikkei index, which lost approximately 40% of its value. Fortunately, this year has proven to be much better with Japan’s leading index posting a positive return of 6.04% YTD, as of July 17. According to Bloomberg data, the Nikkei and the S&P 500 over the last ten years have been correlated by approximately 54%. If corporate earning actually do come out better than expected, this could help to further promote a US equity rally and it is highly probable that the Nikkei will move higher as well.

Ironically, after reviewing price movements for the yen and Nikkei index, you will discover that YTD the yen has depreciated approximately -3.85% against the greenback and the Nikkei index has appreciated approximately 3.81%.

Clearly this illustrates an inverse relationship between the yen and the Nikkei in this current year. Over a ten year period, the yen’s average versus the US dollar is approximately 112. If equity markets continue on its trajectory and the yen reaches its ten year average vs. the US dollar, the Japanese economy could see a resurgence, thus pulling it out of its deflationary vacation.

Disclosure: No positions

Comments

[Mad Hedge F...:]

I just don't see anyway out of their mess. I drove over the Benicia Bridge today, passing over ships unloading Toyotas from Japan. The company’s entire product line was there, from Lexus to Prius to Corolla, baking in the sun, still wrapped in plastic, and unsold by the thousands, the victims of a 40% YOY sales drop. So it was no surprise when the Bank of Japan informed us that wholesale prices in June fell a gob smacking 6.6% YOY, confirming the most dire forecasts that the country is still in the grips of a nearly 20 year economic ice age. This is why the US is not headed for the same big freeze, as many Cassandras are predicting. Japan’s bail out of its banks was a slow motion affair stretched out over eight years. Treasury Secretary Hank Paulson pulled the trigger on a much bigger bazooka with the TARP, a month after Lehman went bust, and Secretary Tim Geithner and the Fed’s Ben Bernanke followed up with their 155 mm howitzer. Tokyo’s insiders made sure well connected “zombie” borrowers have stayed alive to this day. The truly great strength of the US is that creative destruction is a constant, unrelenting, and unstoppable force, enabling the economy to bury its mistakes quickly and move on to the next game. Look at GM. Japan’s fiscal stimulus was an impotent, irregular drip of inadequate packages financing bridges to nowhere. Obama’s hurricane of a $2 trillion budget in his first month provided more stimulus than Japan did in ten years in GDP terms, and now there is the threat of a second package. The bottom line is that Japan never understood the true debacle they were into until it was too late to do anything about it. The US realized in September we were on the precipice of a Great Depression II, and have thrown in everything, including the kitchen sink, to stop it. The US recession may be long and brutal, and the recovery subpar, but we are definitely not looking at Japan’s two lost decades.

Jul 21 09:44 AM

[Darrel Whitten:]

Greater China (including Hong Kong) surpassed the US as China's greatest trading partner way back in 2004, accounting for 20.1% of Japan's trade versus 19% for the US. In 2007, China excluding Hong Kong surpassed the US as Japan's largest trading partner.
It is also the largest importer of Japanese goods.

Moreover, China was responsible for 38% of Japan's economic growth in 2002, but this surged to 68% in 2006.

While a good deal of China's output is exported to the the US and Europe, Japan has become a major export market as well. Thus while it can be argued that a good deal of Japan's exports to China are simply re-exported to the US and Europe, let's put the myth to bed that the US is still Japan's largest trading partner.

Jul 21 10:41 PM

[HaavBline:]

I will take a miracle for Japan to hang on to "The world’s second largest economy" title for another 3 years. But no miracle seems to be on the horizon for them.

Jul 23 03:32 PM

[Mad Hedge F...:]

Whatch the election. Japanese Prime Minister Taro Aso’s call for national elections on August 30 is setting up a potential “black swan” type event. His Liberal Democratic Party (LDP) has ruled for all but 11 months of the past 55 years. But his party’s 18 year effort to spend itself out of an “L” shaped recovery has failed miserably, succeeding only in converting Japan from the least, to the most indebted industrialized country. Think of a 1,000 “bridges to nowhere.” So the opposition Democratic Party of Japan (DPJ) has a real shot here, which has promised to fundamentally remake the economy by boosting social spending, canceling useless construction projects, and encouraging domestic consumption. Remember what a surprise Congress Party win did for India’s stock market? Look at the excellent piece from The Permanent Wealth Investor’s Martin Hutchinson for an analysis of how such an outcome could affect Japan on a stock by stock basis at www.moneymorning.com/2.../

Jul 23 06:47 PM

[HaavBline:]

In India, the Congress Party IS the long governing party, the positive election surprise was that the Congress Party no longer need to partner with the left wing parties in order to rule, thereby, supposedly, speed-up economic reform policies which have been in motion and supported even by the opposition BJP.

The Japanese election situation is very different. The DPJ is formed by several parties with different agenda. They have NEVER rule Japan. Though they will likely win this election and have a chance to govern. Their policies and priorities may change depending on the strengths of each faction in the DPJ from the election results.

Current polls shows only some 25% approval rating for the DPJ leader vs. 8% (no joke!) for LDP's Aso, with some 57% of voters liking neither choice. That to me means potential instability and weak goverment after elections, unless the Japanese voters quickly warm up to a very uncertain future, which they had feared to do in 55 years.

Jul 23 07:53 PM