Email of the day
Comment of the Day

March 27 2012

Commentary by David Fuller

Email of the day

On Japan:
"I hope you are both well and as always thank you for Fullermoney which continues to educate and inform me as much as it did when I first became a subscriber several years ago.

"I am always surprised how few people (particularly here in Japan) are aware of how dire Japan's fiscal situation is, so it was refreshing to read this excellent article by Andy Xie. I think you will find it interesting."

David Fuller's view Thank you for your thoughtful comments and an article which many subscribers are likely to find interesting. Here is a sample:

Japan has only one way out - a massive devaluation. If the stable national debt is 120 percent of GDP, the yen needs to be devalued by 40 percent because devaluation is ultimately equal to the nominal GDP increase. The devaluation is likely to sustain 2 percent to 3 percent of nominal GDP growth for Japan beyond the repricing induced increase, which is necessary to restore Japan's tax revenue. Deflation has caused Japan's tax revenue to decline as a share of GDP. It can be only reversed through restoring nominal GDP. A devaluation of 40 percent can restore Japan's competitiveness against Germany and South Korea, which will lay the foundation for Japan's industrial recovery.

The Bank of Japan is trying to weaken the yen through expanding its balance sheet. It has an asset purchase program of 65 trillion yen and a lending program of 5.5 trillion yen. The two are equivalent to 15 percent of GDP, comparable to what the Fed or European Central Bank have done. The effectiveness is limited so far. Because Japanese businesses, households and investors believe in a strong yen, the printed yen largely stays in the country and just slows down money velocity. The U.S. dollar has risen 10 percent against the yen from last year's bottom. This is probably due to the financial market upgrading its view of the U.S. economy rather than the BoJ's action.

Yen devaluation is likely to unfold quickly. A financial bubble doesn't burst slowly. When it occurs, it just pops. The odds are that yen devaluation will occur over days. Only a large and sudden devaluation can keep the JGB yield low. Otherwise, the
devaluation expectation will trigger a sharp rise in the JGB yield. The resulting worries over the government's solvency could lead to a collapse of the JGB market. Of course, the government will collapse with the JGB market.

The day of reckoning for the yen is not distant. Japanese companies are struggling with profitability. It only gets worse from here. When a major company goes bankrupt, this may change the prevailing psychology. A weak yen consensus will emerge then.

My view - Andy Xie is a prolific financial writer and I have seen a number of his articles, dating back to his early days at Morgan Stanley. He is always interesting, usually controversial and inclined to overstate his case, in my view. Nevertheless, I agree with the general direction of his article but not the degree because it seldom pays to bet on extreme outcomes.

Japan has often been mentioned by Fullermoney in recent months. My comments on 14th March included this question:

Has Japan finally arrived at a Grand Conjunction, in which the yen is actively weakened, opening the door for a meaningful stock market recovery, to which Japanese investors contribute by switching some of their savings from JGBs to equities?

I think so and the yen is the key, shown here breaking downwards against the US dollar (weekly & daily). This has helped Japan's stock market (weekly & daily) to participate vigorously in this year's global rally, albeit from the dire recesses of the 2009 low. JGB futures have broken down out of a probable top formation (weekly & daily). For the record, and these positions were mentioned as they were opened, I have been re-shorting JGBs on this latest rally and I had been long Nikkei futures but took my latest profits today.

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