Tuesday, 15 March 2011

The Japanese want their yen back

It's a rainy day in Japan.

At the time writing three nuclear reactors are overheating; one has been on fire, one may be cracked and leaking radioactive gases. Radiation of 400 millisieverts per hour has been recorded at the Fukushima Daiichi site - 100 millisieverts per year will give you cancer.

Meanwhile the death toll from the earthquake and tsunami hasn't even been evaluated yet. The news media are now largely ignoring this side of things The most recent estimate is 1300 fatalities but it seems quite reasonable to assume the final count will be over ten thousand.

In all this tragedy the Japanese people have shown themselves to be true heroes. There have been no reports of civil disorder; no reports of mass hysteria; no reports of resistance to the decisions of the authorities. The contrast with, say, the New Orleans Katrina hurricane couldn't be greater. In New Orleans even the police officers took to looting TVs from Walmarts.

It hasn't taken long for the commentariate to move from bodies in rubble, to exploding nuclear reactors, to the effects on the world's economy. Will oil go up because Japan needs more to rebuilt or down because Japanese industry is effectively switched off for now, and you can't drive very far anyway? Will their bonds go up due to a wave of patriotic buying (the Japanese people own 95% of their own government's debt) or down because the government will be plunged into a fiscal crisis?

For the last twenty years, since 1990 or so, the Japanese have lived in a deflationary environment. And in a deflation saving is very attractive - your money gains value while it's sitting around doing nothing. The Japanese government has spent the last two decades trying to get the Japanese to spend their cash but nothing doing, the yen just piled up.

Burned by the economic crash of the late 1980s the Japanese housewife, custodian of all money in Japan, decided to save hard in case of future rainy days. However with the government reducing interest rates to ever lower levels to try to get some spending happening Mrs Yamamoto couldn't get any return on her cash, so she sent it abroad where the interest rates were higher.

The yen carry trade, as it became known, moved about two trillion US dollars' worth of yen into the West, into the USA, Europe (mainly the UK), and into Australia and New Zealand. And did we make hay with this abundant cash? Yes, we did! Money became cheap in the West. We took out massive mortgages to buy over-priced houses. We took car loans. We took holidays on the never-never. We partied for a decade.

But our borrowings are Mrs Yamamoto's savings. She was saving for a rainy day. And it's likely that the Mrs Yamamoto needs the cash now to do some work on the house, or to make up for the fact that Mr Yamamoto's factory isn't running at the moment.

Basically Japan looks likely to suck back in all the cash it exported between 1990 and 2007. (After 2007 there wasn't an interest rate differential to make the yen carry trade worth while.) Of course when Western currencies are sold for yen the yen will rise in value. This has already started happening and the Bank of Japan has tried to contain the situation by pumping cash into the economy, but they have their own "meltdown" situation. A couple of hundred billion USD's worth of yen pumping isn't going to stop two trillion USD's of yen being called home.

So money could be getting tight around these parts. If you want a loan, a mortgage perhaps, you may find that Mrs Yamamoto got to the bank first.

The Americans will likely deal with this problem with more dollar printing, aka quantitative easing. Tight money is deflationary, answer: QE. The situation in the UK isn't so clear cut. Our CPI inflation is already double its target, and that's not because we've been giving ourselves greedy pay rises, it's because world commodities have gotten rather expensive. And with Japan sucking in resources to rebuild, commodities aren't going to get any cheaper (after the initial economic hiatus has worn off) and we in the West are just going to have to tighten our belts.

(Additional: Might as well put a stake in the ground. This morning a pound would buy you 132.5 yen. Let's see how that moves over the coming days.)


chefdave said...

Great post. Forex is in no way strong point but I'll have a stab at a prediction. As Yen is essentially Japanese debt I'd expect a foreign sell off as the crisis undermines the economy's ability to repay, this will be amplified by any QE that goes on as well as any increase in imports that will needed for the rebuild, (the japanese will increase their demand for foreign currencies and drive up the price).

So short Yen until the crisis has fully played out. Exogenous shocks tend to always weaken currencies, the same will hold true with Japan.

(my first ever economic prediction!)

Nationalist said...

I reckon the yen will rise, unless the BoJ manages to pump so much cash into the economy they can keep it down. The reasoning is in the post - yen going home (hence UKPs, USDs etc being sold off.)

chefdave said...

On second thoughts perhaps your reasoning is sounder than mine, my mistake was to think of foreigners as owners of Japanese Yen rather than their custodians.

The market seems to be backing you up.