Is A Major Yen Depreciation Imminent?

The 3Q contraction in the Japanese GDP makes the fifth recession since the mid-1990s inevitable next year. However, the recession of 2013 will be unique for the Empire of the Rising Sun as it is the first economic contraction that will coincide with a current account deficit since the Plaza Accords.

Export growth to the US, China, Brazil, Europe and India will only stagnate or even decline. This fact alone means Japanese corporate profits are at grave risk at a time when ROE is a mediocre four per cent in any case, the reason the Nikkei Dow is the only major global developed market stock index that trades near book value.

The uber-strong yen has also become a global haven currency since the 2008 financial meltdown and the SNB’s decision to peg the Swiss franc to the Euro. Appreciation pressure on the yen has been inexorable and triggered a rise in Japanese unit labour costs. It is surely significant that Japanese corporate profitability has fallen despite the post 2011 Fukushima tsunami reconstruction stimulus and a global growth cycle.

This means Japan could well slip back into a vicious cycle of negative GDP growth and deflation.

The DPJ government cannot rely on fiscal stimulation alone to lead Japan out of its economic quagmire. Yoshihiko Noda, in fact, could well be ousted by the LDP’s Shinzo Abe as Prime Minister in the next election. The yen used to trade at 115 – 120 in the years before Lehman’s failure changed the very DNA of risk, money, central banking and international interest rate differentials.

The yen’s role as the world’s haven currency has nothing to do with its lousy fiscal, political and corporate realities. It has everything to do with the safe haven scramble into US Treasury debt and the subsequent plunge in yields.

A nation with six Prime Ministers since 2005 when Shinzo Abe was last PM, a nation with the oldest population in the world, a nation whose public debt is 200 per cent of GDP, a nation entirely dependent on Middle East oil imports and threatened by the military power of China, North Korea and Russia in the Pacific is not exactly my idea of a global safe haven.

I believe 2013 will be the year the world will see that risk aversion does not negate awful Japan fundamentals. This will force the Bank of Japan to aggressively ease monetary policy even as corporate Japan deploys its vast cash hoard in global M&A (as Softbank did with Verizon) and the politicians summon the ghosts of Lord Keynes to build pre-election bridges to nowhere from Hokkaido to Okinawa.

This means Governor Shirakawa at the BOJ will have no choice but to boost his JGB purchases on an exponential scale, akin to the Bernanke Fed’s monetary ease since 2009. The yen can well depreciate to 86 – 88 by June 2013.

My recommendation to sell sterling against the dollar at 1.62 two months ago was vindicated by its subsequent fall to 1.58, even though the Bank of England has not expanded its gilt purchase programme. A sovereign credit downgrade of the UK is a sword of Damocles for sterling as both rating agencies have warned about a potential risk downgrade.

Governor King has publicly warned the City that inflation could well overshoot his target in 2013. This convinces me that the Old Lady of Threadneedle Street wants a lower sterling to boost growth as Chancellor Osborne’s austerity deepens.

A Greek exit from the EMU could be the catalyst that causes sterling to fall to 1.52 in the next three months. This is particularly true if risk aversion on Wall Street and stronger economic data in the US leads to safe haven flows in the US dollar against the Euro.