Why Bank Of Japan Should Keep Selling Yen

Includes: FXY, PCRFY
by: Lok Sang Ho

Panasonic (PC), the Japanese electronics group, expected that it would face a 420 billion yen loss this year. Only last April, the company announced plans to reduce its workforce by 17,000. Yet, despite the cost cutting, the announcement has overturned an earlier estimate of a 30 billion Yen profit for the year ending in March next year.

The reason is very simple: a very strong yen has eroded the company’s profits. Some commentators had looked at Japan’s exports, and noted that Japanese exports had continued to rise notwithstanding the strong Yen. They concluded that the Yen did not hurt Japan’s exports as is often claimed.

In fact, however, behind the rising dollar value of Japanese exports is (a) a shrinkage in physical exports, and (b) a shrinkage in profits or even losses. With a much stronger Yen, assuming prices in Yen stay constant, the dollar value of exports would rise. With prices in Yen suppressed in order to keep sales up, profit will be suppressed. The story of Panasonic, widely regarded as one of the leading and most successful companies in Japan, tells us clearly that the strong Yen is truly eroding the profits of many firms.

The Nikkei index is now hovering below 9000. In the late 1980s it was just shy of 40,000. At that time the Dow Jones stood at less than 3000. On the last day of October 2011, the Dow Jones closed at 11955. The P/E ratio for the Nikkei market is roughly 16 times; that of the New York market roughly 13 times. Although the P/E ratio in Japan was unreasonably high in the late 1980s, still, the relative changes in profitability of Japanese and American companies over the years is mind boggling.

Until quite recently Japan was still suffering from a degree of deflation, suggesting that its currency is overvalued. Before profitability returns, it will not make sense for export-oriented Japanese firms to invest or to hire. Japan has long lost its role as a growth engine for Asia. An excessively strong Yen that totally ignores its national debt of well over 200% to the GDP, persistent and large fiscal deficits, and still historically high unemployment notwithstanding, a fast aging and much aged population, does not do any country any good. The Bank of Japan should aggressively sell Yen.

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