Sunday, November 25, 2012

I think I'm Turning Western

Japan is turning into the United States. Usually, the comparisons flow the other way around, with pundits saying that the United States might be going Japanese, due to all the economic stagnation, deflation fears and general malaise. After all, Japan is into its third lost decade, after also having a huge real estate (and stock) bubble. In the past, I've already written that due to several factors, the United States is not like Japan. These factors were: Demographics. The U.S. population is still growing, Japan's isn't; Valuation. U.S. stocks are much cheaper than Japanese stocks were or are. Inflation. For all the fears of deflation, the U.S. has had consistently higher inflation since the popping of its stock and real estate bubbles when compared to Japan. So, for the most part, one can't really say the U.S. is turning into Japan. Or at least there are very obvious differences between the two cases. But today I am going to make a different suggestion. Quite the other way around, it might be Japan that's turning into the United States! And that doesn't mean anything good, because Japan is taking the worst of its own situation, and adding it to the worst of the United States' own travails. Why is Japan turning into the United States? After its giant real estate and stock bubble, Japan's economy fell into the general malaise it's been in ever since. This malaise has led the Japanese state to run huge budget deficits and as such, to accumulate a huge public debt-- and to no avail as the malaise continued. It also led the Bank of Japan to print money left and right, much like the Fed today with the quantitative easing programs. But something still set Japan apart from the United States all this time. Japan had a large trade balance surplus, whereas the U.S. had a huge trade deficit. Japan also had a population bent on saving heavily, where the U.S. population for the most part was spendthrift. The thing is, for many different reasons this isn't the case anymore. On one hand, things like quitting on nuclear energy and having to import more energy goods, China economic weakness, China Japanese-focused xenophobia and Japanese corporate weakness have led to Japan losing its trade surplus (see chart below: Source). On the other, Japanese demographics destroyed its saving ways. (click to enlarge)
So there you have it. Whatever meant that Japan's travails were mostly internal, is now inapplicable since if the country starts running a trade deficit, it will at some point need external financing. What you are left with is a country with 211.7%/GDP public debt, a 9.7%/GDP budget deficit, a declining population AND a trade deficit, while printing money! What you're left with is the U.S. minus a growing population! Not only that, but the numbers are actually much worse to boot. Conclusion Amazing as it is, this doesn't bode well for either the Japanese yen (FXY),(YCL),(YCS),(JYN) or for Japan's stock market (EWJ),(EZJ), even after having fallen more than 75% in the last 22 years. I am thus turning long-term negative on JPY. On the plus side, as the Japanese yen tanks, it might be possible to find Japanese equities which rely mostly on foreign markets and stand to benefit. Finally, some would say that the very best way to play this trend would be to short JGBs. The problem here is that JGBs are issued in yen and Japan can print as many yen as it likes and buy those bonds, so it's not a given that JGBs will collapse. It will be mostly an (unlikely) political choice to let those prices reflect reality. Not so with the JPY.

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