This month’s chart highlights the currency challenges faced by new Japanese prime minister, Sanae Takaichi. As a protégé of former prime minister Shinzo Abe, Takaichi-san has sparked comparisons to her predecessor’s “Abenomics” policy programme, which ushered in a new economic era for Japan characterised by loose monetary policy, expansive fiscal policy, and structural reform. These comparisons have led to a further fall in the value of the yen since Takaichi-san was elected leader of Japan’s Liberal Democratic Party (LDP).
However, before they dust off their Abenomics playbook, investors should be mindful of the very different economic environment that now exists in Japan compared to back in 2012. Not least the cheapness of the yen, which suggests to us that policy may now be directed more towards currency stability than currency weakness. There are several reasons for our thinking:
- A weak yen worsens affordability for Japanese households. While funding fiscal expansion with the help of an accommodative central bank may therefore be tempting for politicians, it’s not a free option as it reduces the purchasing power of currencies and impacts consumers. What was politically acceptable when the yen and inflation were at 2012 levels may not be today. Takaichi-san has recognised that part of the reason she was elected LDP leader was to tackle the rising cost of living. As a result, she has vowed to end high cost-push inflation—something that will be very difficult to achieve if the yen continues to weaken.
- Japanese firms are not passing on the benefits of a weak yen. LDP party members are not incorrect to state that there are pros and cons to a weak yen, but by keeping the yen deliberately weak they are picking the economic winners and losers. Japanese consumers lose out by paying more for goods and some services, while producers are the winners, thanks to the advantage they gain in export markets. The idea was that producers would share these gains with their employees by paying higher wages. But firms have kept most of the gains from the weak yen while consumers, who vote, now feel worse-off (although equity holders have benefited).
- Currency weakness has left the Japanese poorer. As this month’s chart shows, Japan’s GDP per capita on a purchasing power parity basis has already fallen sharply relative to the US in recent decades, leaving the country poorer compared to its international peers. The impact has been most visible via the huge numbers of inbound tourists arriving in Japan. But further yen weakness would likely only lead to further relative economic decline.
- Japanese investors have significant US dollar risk. After close to 15 years of a weak yen policy, Japanese investors have close to $3 trillion of US dollar assets in portfolios, much of which is unhedged. Should our US dollar smirk framework hold, which suggests the dollar’s downside protection is no longer reliable, then in a risk-off environment any large drawdown in US dollar assets could lead to a much stronger yen—and potentially severe losses for Japanese investors in yen terms.