The downfall of the Japanese yen was the big story of November in currencies. The yen retreated across the board and moved more than any other major currency.
The main reason is the much stronger rhetoric from politicians towards the elections. Japan holds elections in December 16th and this could start a year of even greater downfalls for the currency. Let’s see why:
* This article is part of the December monthly forex report. You can download the full report by joining the newsletter in the form below.
So far, the Bank of Japan had an inflation target of 1%, but was unable to achieve it. Recent figures show that Japan is still suffering from deflation: a situation where prices are falling, consumers are reluctant to buy, prices keep falling, etc.
Pressure on the BOJ has grown due to this failure and also due to a political struggle within Japan. The BOJ is fighting for its independence. The current government led by Yoshihiko Noda (formerly a finance minister) and his DPJ found itself calling early elections, despite trailing in the polls.
The leading candidate to replace Noda is former PMI Shinzo Abe, leader of the LDP. Abe presented a very ambitious plan. This includes an inflation target of 2-3% and more importantly, he suggested a massive reconstruction program to rebuild Japan. How would that be financed? By having the BOJ buy these construction bonds. Abe has since backtracked on this, saying that he would not tell the BOJ exactly how to reach its targets, but he did stick to the 2-3% inflation target.
There are other open issues that weigh on the yen:
- Energy Shift: Following the catastrophic earthquake, tsunami and nuclear disaster of March 11th 2011, Japan closed nuclear installations, at least temporarily. Without too many natural resources, the country now imports energy and this changed its once favorable trade balance: from a surplus to a deficit. For quite a while, the wider Current Account figure remained positive. Yet for the first time in decades, Japan reported a current account deficit in October. This is big news, as it reflects a big shift in were money is going.
- Islands Dispute: While the world media moved on from the dispute between China and Japan on the islands, there is no resolution in the horizon. Sino-Japanese trade has been hurt and uncertainty looms. This is damaging for Japan, China, and the entire world. For our case, it hurts Japan’s export oriented economy. Abe might take a tougher stance on the islands dispute.
- Mountain of debt: Japan has a debt-to-GDP ratio of more than 200%. Yes, worse than Greece. However, contrary to most countries, most of Japan’s debt is held at home: by Japanese individuals and institutions. With the ageing population, pension funds have to sell Japanese bonds in order to pay pensioners. This is gradually causing a shift, though very slowly.
Abe has a significant lead in the polls. If he is indeed elected on December 16th, it will be important to follow his statements and how he acts as PM. Jim O’Neill from Goldman Sachs already said that the yen is on the verge of the biggest shift in direction since 1985 – since the Plaza Accord.
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