There’s a pretty boring status quo in Japan. The yen is strong. Bond yields are low: buy a ten-year Japanese government bond (JGB) and you’ll get a yield of under 1%.
And the equity market is cheap: smaller companies trade on an average price-to-book ratio of around 0.8 times – which means that, in theory, you could buy them, shut them down, sell their assets and walk away with a pile of cash.
Last year, just after the Great East Japan Earthquake, a strategist told us that these valuations only made sense if “the very existence of Japan is at risk”. It isn’t and they still don’t.
At the beginning of almost every year, lots of people predict that at least one of these things will change. Some say that the yen will collapse, leading the country into a hyperinflationary nightmare. Others say that the long-awaited Japanese fiscal crisis will finally kick in and bond-market yields will soar.
And, of course, I predict that the equity market will start to move up to some kind of fair value (note that the average price-to-book ratio in the US is more than two). How bored you must all get of us.
Everyone has their own excuse for their forecasting failures. Mine is the yen. Ask any Japan fund manager why their stocks are failing to deliver, and they will all say much the same as John-Paul Temperley, of the Martin Currie Absolute Return Japan Fund, did in December: it’s the “bloody currency”.
In 2007, you could get 125 yen for a dollar. Now you get about 78. The yen has also been rising fast against the currencies of its exporting competitors such as Germany and Korea. That makes anything made in Japan relatively more expensive. Japan’s big exporters still dominate the stock market (although exports make up only 11% of GDP), so this matters. When the yen rises, the market falls. When the yen falls, the market rises.
So why is the yen so strong? The answer is that, for all Japan’s faults, it is a safe haven. In the world of currencies, everything is relative and among the global currencies the yen is the only one that doesn’t represent an area with an incurable problem.
It might not be growing, but its banks are solvent, its corporate balance sheets are strong, and there are moves afoot to double – and then triple – consumption tax, to deal with its shocker of a budget deficit.
The Bank of Japan is also pretty much the only big central bank not to have wholeheartedly entered the global currency wars. Most of the world’s other big trading nations endlessly manipulate their currencies.
The US has indulged in huge quantative easing (QE) (printing money tends to weaken your currency). So has the UK. China never stops with the interventions. Germany keeps its export economy going by staying in the euro and piggy-backing off the currency weakness caused by Greece and Portugal. And even Switzerland, the one-time goody two shoes of international monetary policy, has drawn a line in the sand with its cap on the franc’s appreciation.
Yet the Japanese – whose “beleaguered manufacturers need a strong yen like they need a hole in the head”, as Société Générale’s Albert Edwards puts it – have done almost nothing to stop the rise of the yen. In Edwards’ opinion, that makes it time for Japan to ride roughshod over its central bankers and “intervene in unlimited quantities to drive the yen lower. It is time to do a Switzerland”.
That would, of course, come with a downside: Japan might also get a runaway rise in domestic money, a credit bubble, and a fast rise in asset prices.
On the plus side, that is exactly what most investors in Japan dream of. It is time, says Edwards, to make that dream (and as a pleasant side effect, my forecasts) “a reality”.
This isn’t going to happen immediately. The Bank of Japan has a remit to keep prices stable so 0% inflation suits it well, as does Japan’s ageing population. Train fares haven’t risen in Tokyo in 18 years and that’s the way they like it.
However, politicians have started to go into battle on the subject and they now have good reason to step up the pressure. This week, Japan announced that it imported more goods than it exported last year. That’s the first time since 1980 – and it isn’t a good thing. It might even force the Bank to note the fact that, right now, success in a globalised world is all about having a weak currency.
I’m sticking with my Japanese holdings while they think about it.
• This article was first published in the Financial Times.