Safe Haven No More?

The incoming Japanese administration, under Prime Minister Shinzo Abe, has just announced a further stimulus package worth approximately $116 billion. The purpose of this injection of capital into the Japanese economy is to create some 600000 jobs and help ease Japan’s (relatively, in Japanese historic terms) high unemployment level. The funds will be used for infrastructure projects aimed at rebuilding in the wake of the March 2011 earthquake and tsunami. It will also provide incentives for businesses to increase investments and as a whole, could increase the economy by 2%.

Japan is currently in recession and has long suffered from price deflation. Deflation means that goods within Japan become cheaper over time and this hampers demand since consumers put of major purchases for as long as possible in order to profit from falling prices. The nation has the greatest debt burden on the planet and a demographic time bomb to deal with in the shape of a falling birth rate and an aging population. This means that tax revenue will tend to decline (unless taxes are raised) and social security payments will rise due to pension and health provision expenditure as time goes by.

Japan is an exporting nation and its exports have been hit recently by a combination of weak global demand, a strong Yen and a territorial dispute with China which has fuelled long-standing animosities leading to reduced demand for Japanese goods in the Chinese market.

Japan was seen as a currency safe haven during the global financial crisis. In part, this was due to the fact that few other viable candidates existed and that the Yen was relatively weak then. Many financial institutions had taken advantage of cheap Yen loans (as a result of Japan’s long-standing near zero percent interest rate) and as the crisis developed these needed to be repaid (in Yen), pushing up the value of the currency.

The new administration has made it clear that they wish to see the Yen depreciate – indeed, it has already fallen by 12% since November against the US Dollar. Given this position, investors may start to unload their Yen positions since the value of those holdings will fall. At the moment, some of these investors will have made handsome profits because of the strong Yen. If the perception that the Yen is a safe haven currency is lost, the depreciation of the currency could be quite steep as money is repatriated into other currencies. Japan's economy has been hurt by a dip in exports amid slowing global demand and subdued domestic consumption.