Money Choppers Over Japan

| About: iShares MSCI (EWJ)


Japan has been suffering crippling economic conditions for multiple decades.

Despite the BOJ's best efforts, the yen continues to strengthen.

The only solution of the BOJ is to do something drastic to massively devalue the yen.

Japan is a mess. From crippling deflation to a massive demographic crisis, nothing they've done in the past few decades has been able to kickstart growth.

You can see from the graph below that household spending has either been flat or downtrending for over 20 years. At the same time, the working age population continues to plummet. This leaves the economy straddled with debt and with few options for relief.

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Just 3 years ago, Japanese Prime Minister Shinzo Abe launched his Abenomics plan to answer these problems, but we have yet to see any sustainable results.

Abenomics is based on "three arrows" - monetary easing, fiscal stimulus, and structural reforms. Only the monetary arrow has been shot so far, with the Bank of Japan using quantitative easing to weaken the yen. A weaker yen would boost corporates because of their reliance on exports. Cheaper products due to a cheaper yen would drive sales higher, which in turn would spur growth.

The plan worked for a while. The yen weakened (USDJPY trending higher means a weaker yen) and Japan's Nikkei (NYSEARCA:EWJ) (NYSEARCA:DXJ) index shot up. But unfortunately, everything started to reverse again last year. The yen began strengthening once more and sent the Nikkei sprawling lower.

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The yen's recent strength has not only ruined many of the BOJ's previous efforts, but also destroyed confidence in the entire Abenomics plan. This has created a positive feedback loop where the yen continues to strengthen as investors lose faith in turnaround efforts and retreat into perceived safe assets like Japanese bonds (which are purchased in yen, thereby, strengthening the currency even further).

The market has long been expecting the BOJ to intervene with drastic measures to reverse this trend. But this is yet to happen. Expectations were high for their April meeting, but they didn't act. Expectations were once again high for June's meeting, but the BOJ did nothing, yet again.

Consumer prices have fallen 0.4% from a year earlier in May, the largest drop since Abenomics was first implemented. March and April also showed continuing disinflation.

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All eyes are now on the BOJ's July 28th meeting. The fact that "Helicopter Ben" Bernanke recently visited BOJ Chairman Haruhiko Kuroda has fueled speculation that the BOJ is finally about to go nuclear. The yen has fallen over 6%, as a result.

Bernanke's visit is significant because of his connection to "helicopter money." Back in 2002, Bernanke made a speech about preventing deflation with "helicopter money." Helicopter money obviously doesn't mean dropping cash from the sky onto the public - though it's not much less ridiculous. It's essentially straight money printing debt monetization. The way the Japanese government will probably go about it is by issuing zero-coupon perpetual bonds.

A zero-coupon perpetual bond is one that offers no interest payments and never matures - meaning the principal is never paid back. Basically, the Japanese government would issue these bonds and the BOJ would print money and buy them up. This would create a direct transfer of cash from the central bank to the government. The BOJ would keep the bonds on its books permanently, and in return, the government wouldn't have to worry about interest or principal payments. They essentially receive free money.

Great scheme, right?

Billions and billions (even trillions... why not?) can be transferred in this manner and can then be turned around and used in the real economy through "costless" deficit spending and government transfers. The extra spending may temporarily boost the economy. And it will also, severely degrade the value of the yen. In the short term, we can expect USDJPY to return to the 150 level… and after that 300 and beyond?

The question now is whether the BOJ will hop on Ben's helicopter and surprise the market in next week's meeting - we won't be surprised. The market is already expecting further easing, so for the BOJ to really have an impact, they need to announce something drastic. This will convince the market of potential future inflation and solidify the reversal in the yen trend.

The BOJ's announcement could be the first domino to fall that reignites the currency wars. The yuan has already begun to weaken significantly, and we can expect that trend to accelerate if/when the yen turns around. Other countries will also follow suit with currency devaluations to ensure their exports stay competitive. The supposed "Shanghai Accords" established between international governments to manage dollar strength will fall apart as each country decides to put themselves first. The massive global devaluations will in turn bolster dollar strength and kickstart the bullish USD trend. And a stronger USD may finally be the factor that topples US equity markets.

Our team at Macro Ops is slowly loading up our book with long dollar positions, while keeping a close eye on our US equity positions. Things can change very quickly in the next few weeks. It pays to stay agile.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.