Japanese Yen

If you follow economic news than you have most likely heard the term “Abenomics,” which refers to the economic policies of newly elected Japanese Prime Minister Shinzo Abe. What exactly does this term mean, and how will Abenomics impact the global economy. Abenomics refers not just to Abe’s economic policies also the general approach he is taking to attempt to revitalize Japan’s economy. So far this approach appears to be centered around two key policy initiatives. One initiative appears to be the controlled devaluation of the Japanese Yen (shorting the Japanese Yen has been one of the most popular hedge fund trades), the other is a massive increase in public spending to try to jump start the economy.) Both of these moves threaten to devalue the Japanese Yen, which in turn could spark responses from other national governments.

As mentioned, one of the central concepts of Abenomics is devaluing the Japanese Yen. Currently, the Japanese government is maintaining ultra-low interest rates, currently set between 0 and 0.1 percent and has also launched a quantitative easing policy to buy up assets. During quantitative easing the monetary authority creates new money that it then uses to buy assets, such as mortgages and national debt. The combination of quantitative easing and low interest rates, among other Abenomic policies, has pushed the Japanese Yen down from 76.5 Japanese yen per dollar in September of 2012 to just over 93 Japanese Yen per dollar as of February 2013.

While many people may immediately think that devaluing a currency is bad for the domestic economy there are actually numerous upsides. Devaluing a currency will make exports cheaper and imports more expensive. This in turn has numerous and potentially dramatic effects on the domestic economy, both good and bad.

Cheaper exports increases the likelihood of success for export oriented companies. This, in turn, should create jobs at local firms and should bolster the manufacturing sector. Manufacturing has long been vital for the Japanese economy. The Japanese maintain some of the most advanced and efficient manufacturing facilities and capabilities in the world. Most major Japanese firms, such as Sony Corporation (NYSE:SNE) (TYO:6758), Toyota Motor Corporation (NYSE:TM) (TYO:7203), and Panasonic Corporation (NYSE:PC) (TYO:6752) rely on the sale and especially export of manufactured goods.

By devaluing the Japanese Yen it becomes cheaper for foreign companies to purchase goods from the exporting country. Let’s say that a Japanese DVD player costs 5 thousand Japanese yen to purchase. In September of 2012 this would have cost you roughly 65 American dollars. As of January 2013, however, it would cost only 53 dollars. The cost savings is huge and makes Japanese products far cheaper to purchase.

While exports become cheaper, however, imports become more expensive. This could raise the cost of food, clothing, and other imported items in Japan. And while the Japanese might be able to lower prices by producing such goods locally, other inputs, such as Energy, are more difficult to produce by local means.

A dropping currency also tends to stoke inflation. Currently the Japanese government is targeting a 2% annual inflation rate, a healthy number for an industrialized economy. If the Japanese government is not careful, however, the inflation rate could grow more quickly and dampen the economy. Rising inflation rates tend to restrict business growth and also place added pressure on families.

The other stimulus measure is increased public spending. Japan has tried this tactic for years and now Japan’s debt levels are about 250% of their GDP. How then can the Japanese afford more stimulus?  Using quantitative easing the Central Bank to create money and to then use that money to purchase sovereign debt. This allows the government’s plans to deflate the value of the Japanese Yen and to increase public spending at the same time.

So far the short term impacts of Abenomics have been largely positive. Deflation has been wiped out and the government appears to be on track to meet its inflation target. The Japanese stock market has responded positively, posted a 7 percent gain through January 2013. It’s too early to tell if the public spending packages will jump start the economy but early signs appear positive. Still, critics have pointed to the risk of asset bubbles as money grows too cheap and the risk of hyper-inflation. At the same time, Japan’s debt levels are already viewed as unmanagable and previous government stimulus packages proved to be in effective. The jury is still out on Abenomics but the results should be interesting either way.

What could turn out to be more important, however, is how governments around the world respond. Already the G20 has had to come forward and issue a joint statement that countries are not going to engage in a currency war. The United States government, among others, has flatly denied that it is trying to lower the value of the dollar through quantitative easing efforts and other tools.

In spite of denials, Japan’s moves could spur a currency wars with governments around the world taking action to lower the value of their currency to make their exports cheaper abroad. A currency war occurred during the early stages of the Great Depression, contributing to the instability that would essentially destroy the global economy. With governments being crushed by large national debts and struggling to maintain exports, a devalued currency could be viewed as an answer for national problems.

So far governments, including Japan, are claiming that the dropping value of their currencies is caused by the side effects of policies meant to stimulate economic growth and encourage stability in financial markets. Yet, there is fair reason to wonder if quantitative easing efforts in the United States, Japan, United Kingdom, and elsewhere along with stated goals by numerous central banks to maintain moderate inflation rates, are actually be used to lower currency prices. Central Banks could be quietly trying to lower the value of their national currencies. Whether or not a currency war could break out remains to be seen but if a war does occur “Abenomics” could turn out to be one of the key dominoes to fall.