Currency Of The Month – Japanese Yen: Land Of The Rising Sun’s Lost Two Decades

As many readers of the Daily Pfennig® newsletter will undoubtedly recall, there was a time in the not too distant past when the Japanese economy was envied (and somewhat feared) by most of the global economy. A time when Japan dominated the global export market in electronics and automobiles; when global industrial firms clamored to emulate Japanese manufacturing methods and exacting quality controls; and when standards of living for Japanese citizens climbed to rival or even surpass some developed western nations.1 For the Japanese yen, which translates into English as “round” or “round object,” the 1950s, ‘60s and ‘70s were a period of an eternal sunrise.

Yet today, Japanese economic growth is a mere shadow of its once-revered position on the global stage. Between 1981 and 1995, the economy grew substantially, from $1.2 trillion USD to $5.3 trillion USD. However, in the past 20 years, Japan’s economic production has declined from $5.3 trillion to $4.6 trillion USD, with the country’s current gross domestic product (GDP) at levels below economic production from 20 years ago (Figure #1).

Fig. #1

Japan’s GDP In Current USD (1981-2015)

Source: EverBank Research Team, based on an analysis of publicly available data from The World Bank.

Japan’s tale of triumph and woe is as old as the fiat currency. Japan’s period of post- World War II prodigious economic growth eventually led to excessive liquidity and more lenient lending standards within the Japanese banking system. By the mid-1980s, this successful growth created an environment where excessive investment risks were undertaken, including such memorable investments as the acquisition of the Pebble Beach Golf Club, Rockefeller Center, Columbia Pictures, and the partial funding for the leveraged buyout of RJR Nabisco, Inc. in the fall of 1988.2 The systemic liquidity further led to speculative bubbles in domestic real estate and investment assets, with commensurate increases in personal wealth, corporate wealth, and consumer spending.

By the late 1980s, the Bank of Japan (BOJ) was concerned enough about rising asset prices that it tightened its monetary policy, setting off a dramatic drop in the Nikkei stock market index from 38,916 at the end of 1989 to 12,000 by 1992.3 As stock prices and real estate asset values dropped, bad loans and investment losses created a banking crisis throughout the Japanese system, while the effects of the 1985 Plaza Accord, which increased the value of the yen relative to the dollar, further dampened the country’s export activities. Despite aggressive and persistent cuts in interest rates beginning in the early 1990s, the BOJ was unable to stem the damage created by the bursting of the asset bubbles. Twenty years later, it continues to fight the battle of economic stagnation and deflation (Figure #2).

Fig. #2

Change In BOJ Discount Rate (01/1986-11/2015)

Source: EverBank Research Team, based on an analysis of publicly available data from The St. Louis Federal Reserve Database (FRED).

Source: EverBank Research Team, based on an analysis of publicly available data from The St. Louis Federal Reserve Database (FRED).

Japan Economic Overview

Throughout the past 20 years, the Japanese government and its central bank have all but perfected the Keynesian playbook for modern day central bank monetary intervention, characterized by enduring low interest rates, quantitative easing (QE), government spending, debt accumulation, and currency debasement. And yet, a casual observer can clearly see that the results of these efforts have been less than stellar in terms of rekindling economic growth (Figure #3). Despite these extraordinary measures, for the majority of the past two decades, the Japanese economy has expanded at less than 2% per year, a distant memory of the 4% average GDP growth during the 1980s and 5% growth throughout the 1970s.4

Fig. #3

Growth Rate Of Japan’s GDP

Source: EverBank Research Team, based on an analysis of publicly available data from The World Bank and Statista.

While the level of economic stimulus has been appreciable, the results have not met expectations, and the economic damage has certainly been palpable. In 2014, Japan’s trade deficit was estimated at 7.1% of GDP, ranking the economy 194 out of 218 countries throughout the world.5 With accumulated public debt at more than twice the nation’s GDP, Japan ranks dead last in terms of government debt-to-GDP. As compared with the conventional poster-children for fiscal mismanagement (Greece, Italy, Portugal & Spain), Japan appears to be in a world of its own (Figure #4).

Fig. #4

Japanese Govt. Debt-to-GDP Vs. Euro Union’s P.I.G.S. (2014)

Source: EverBank Research Team, based on an analysis of publicly available data from The CIA World Factbook.

And yet, the Japanese government continues to double-down on its efforts to fuel the economy with more spending, as evidenced by Prime Minister Shinzo Abe’s 2012 stimulus program that included massive monetary stimulus, increased government spending, and significant economic reforms.6 The execution of which, of course, relies on the government’s ability to source this debt. Traditionally, the Japanese government has benefited from its citizens having one of the highest savings rates in the world – upwards of 12% during the mid-1990s.7 This face of Japan, however, has also changed, as an aging workforce has been drawing from savings, and a younger generation has been spending more than it earns with savings rates dropping below 0%.8

Although Prime Minister Abe continues attempts to repudiate Albert Einstein’s definition of insanity – that is, doing the same thing over and over again and expecting a different result – the core problem with Japan’s flagging economy may not be monetary in nature, but rather, simple demographics. Not coincidentally, since the mid-1990s, Japan has been struggling with a precipitously falling population. As of February 2015, Japan’s population of 77.2 million working age citizens dropped to levels not seen since August 1978, with little indication for an inflection point on the horizon (Figure #5). With this level of population drop, it is difficult to see how any level of monetary stimulus would help to restore Japan’s lost growth prospects.

Fig. #5

Japan’s Working Age Population (15-64), In Millions

Source: EverBank Research Team, based on an analysis of publicly available data from The St. Louis Federal Reserve Database (FRED).

How Does It Look For The Yen?

If there is one tenant of the government’s recent monetary and fiscal strategy that has been particularly successful, it has been a weakening of the yen. In an effort to hasten export activity, the government has been actively debasing its currency through massive fiscal deficits and accumulating higher government debt levels. The yen’s “race to the bottom” has certainly produced tangible results, especially relative to the nation’s closest exporting competitors (Figure #6).

Fig. #6

Spot Return Relative To The Yen (12/2012-12/2015)

Source: EverBank Research Team, based on an analysis of publicly available data from Bloomberg.

Yet, in 11 of the past 12 months, Japan has produced a trade deficit, generating a total trade deficit of $40 billion USD for the trailing 12 months ended September 2015.9 During 2014, Japan’s trade deficit was an estimated $99 billion USD, indicating a clear year-over-year improvement, but nevertheless concerning for a country relying on exports for nearly 20% of GDP.10 In comparison, Germany generated a trade surplus of $304 billion USD during 2014.11

As I see it, Japan will need to address two major structural issues before the yen can regain a long-term foothold within the global currency market: declining demographics and expanding government debt levels. At this point, the Japanese government appears unresponsive to both concerns. As such, investors may want to similarly remain cautious with long-term investments in the Japanese yen.

Until the next Daily Pfennig® edition…

Chuck Butler
Managing Director
EverBank Global Markets Group