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The growth in Japan has put a pressure on the risk appetite in London Session. The Yen climbed to 85.20 following a much lower than expected reading. Fears of the world’s third largest economy slowing down into the second quarter of the year prompted Yen to once again act as a safe heaven. With the latest reading of the Chinese and Japanese economy data, we finally have seen a predicament coming for years: China has overtaken Japan as the second largest economy in the world. Japanese economy grew at a timid 0.4% pace in the second quarter, coming well below the estimates of 2.3% annual pace.

With deflation still plaguing the nation and GDP possibly falling in a negative territory in the second half of the year, investor’s and economist’s fear for the worst. The worst case scenario on the table for Japan is a stagflation, when deflation and negative growth both weight down the economy. There are not too many solutions, when the problematic circumstances arrive. Nonetheless, the government is battling hand and fist to avoid the undesirable.

First and foremost, the Japanese government is participating in the quantitative easing program. Quantitative easing includes fiscal and monetary actions to jump start the economy through artificial measures. Secondly, the newly elected government is proposing to alter the economy. The officials are attempting to add growth to the economy internally by creating a greater demand domestically from a consumer. In turn, the Japanese government is hoping this will be capable of simulating the same kind of economy that the United States has. In short, Japan wants to become a consumer-driven economy, not export-based economy. There are many advantages and disadvantages for this, yet in order to circumvent to the following they need to raise the value of the currency. By raising the value of the currency, the demand internally will finally originate as it will be cheaper for the consumer to purchase goods. The government in turn is risking a lot, possible persisting of inflation and continuing weight down of the economy as corporate businesses fail to make adequate profits.

The Yen, on the other hand, has a potential to rise in value. Adding to the premise is Chinese accumulation of Samurai Bonds (Japanese Treasuries) and slow diversification away from US treasuries. China sold $24 Billion worth of US treasuries, while acquiring as much as $14 Billion of Japanese treasuries. The flows will undeniably help the Yen to appreciate against the Dollar. For the time being, the tide might change, however, the Dollar will be under tremendous amount of pressure as the Chinese diversify their holdings.

Disclosure: No positions

Source: Japanese Economic Problems Are Positive for the Yen