The Trouble With Japan’s Weaker Yen Policy

You have to give it to those Japanese. They know how to put on a show. The Nikkei 225 had a lazy 636 point gain on Monday while most Australians enjoyed a public holiday. The gain was good enough for a 4.94% rise in the index. It just goes to show you that those who are determined to ruin the world's financial system have a nearly inexhaustible arsenal of bad ideas.

To begin with, Japanese officials revised annualised first quarter GDP figures upward from 3.5% to 4.1%. Then came the news that bank lending was up 1.8% in May. This was put forward as evidence that the money flood of Abenomics is finally starting to reach the real economy.

But the most surprising news was the growth in Japan's current account surplus. Japan's April current account surplus was 750 billion yen, or around $7.8 billion. That was double last April's figure and comes after the lowest annual surplus ever recorded in 2012. Why is the current account surplus a surprise?

The current account is made up of the balance of trade plus the net income earned on foreign investments. The trouble with Japan's weaker yen policy is that it's actually driven a 10-month string of consecutive trade deficits. That's the longest run of monthly trade deficits since 1980. And it's the opposite of what the Japanese hoped a weaker yen would do.

The weaker Japanese yen may boost exports here and there. But it makes imports more expensive. And for a country that imports nearly all of its energy, the yen crash has resulted in higher energy import prices and regular trade deficits. That's one of the dirty little secrets of currency wars. They always end up costing the people who can least afford rising prices.

Yet the flip side of the weaker Japanese yen is a current account surplus. The income Japanese earned on foreign investments far exceeded what foreigners earned on their Japanese holdings. That's why the current account is in surplus. The Japanese made a killing on their foreign stocks and bonds.

Or did they? You don't make a lot investing in 30-year US government bonds these days. But even at a 3.37% yield, US bonds must look pretty attractive to Japanese investors with negative real interest rates. And so you can imagine the Japanese have been selling domestic bonds and buying foreign investments.

But the gain in income earned on those foreign investments must surely be attributable to currency depreciation. You'd make more yen repatriating your foreign profits back to Japan. But the 'gain' is exchange rate driven. And it's likely Japanese investors, like everybody else, would have to take ludicrous risks hunting for 'yield' overseas.

Maybe all that will change now that Japan's Government Pension Investment Fund is raising its allocation to stocks from 11% to 12%. One percent doesn't sound like a lot. But when it's one per cent of $1.16 trillion in assets - the world's largest public pension fund - then it's a bigger pebble dropped in the pond of liquidity. Waves were made.

When you have trillions of dollars in pension money at your disposal, at the beck and call of the central planners, it doesn't take much to manipulate a market. This is especially true when you're dealing with a price weighted index. Take a look the chart below and you'll see what we mean.

Source: Bloomberg

Fast Retailing Company Ltd is a holding company. Its main subsidiary is clothing maker UNIQLO. You might recognise the brand name. UNIQLO sponsors professional athletes like tennis player Novak Djokovic. All of which is very nice. But what's the point?

Well, the point is, Fast Retailing Company is up 109% in the last twelve months. It's the seventh biggest stock on the Nikkei 225 by market capitalisation. But it easily has the largest percentage gain in the last year, which makes sense if you put that a Japanese retailer is going to boost sales as the yen dives.

The table below shows that seven largest Nikkei 225 stocks by market capitalisation and their share price increases in the last twelve months. The biggest stock on the index is Inpex, Japan's largest oil and gas company. It seems to have bucked the trend of rising share prices over the last year. But not so with the other six.

With returns like that in blue chip stocks, and with the government pension fund ready to buy more stocks, you have to wonder how much longer Japanese investors will look abroad for yield. But if they do, Australia would appreciate some yen love, especially with so many large US-based money managers going bearish on the Aussie dollar. Regards,

Dan Denning
for The Daily Reckoning Australia