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It was stated here months ago that the Bank of Japan was going to take measures to reverse the deflation that was wreaking havoc on the Japanese economy. I predicted that as a result the yen would weaken to the level of 100 to the dollar by the end of the year. That is because the BOJ would be buying corporate bonds and the like in an effort similar to the actions of the US Federal Reserve Board’s “quantitative easing.” Theoretically this would flood the economy with yen, leading to inflation. That in turn would stimulate the business climate by encouraging consumers to spend money. After all, deflation causes buyers to delay purchases because goods will be cheaper in the future. So inflation is the key to reversing that trend.

So what happened? At first things went even faster than most people expected. The yen weakened rapidly, in fact, so rapidly that European governments lodged formal complaints that the Japanese were pursuing mercantilist policies that were disrupting trade. After all, a weaker yen made Japanese products cheaper, and the Europeans worried that the upshot was that Japanese businesses, especially automobile manufacturers like Toyota and Honda, were given an unfair trade advantage. With the yen plunging from ~80 to the dollar down to ~102-3 to the dollar in a matter of months, that was a reasonable reaction. For a company like Toyota, the result was an increase of billions of dollars in profit.

Japanese officials scrambled to address the European concerns. That included Prime Minister Abe Shinzō, who met with several leaders, including US President Obama, to defend his policies, dubbed “Abenomics” in the press. (In Japanese, those policies are called “Abe no mikusu,” or the “Abe mix.”)

With some effort, those critics were mollified, and the BOJ’s inflationary activity continued. Abe’s popularity soared at home, Japanese business seemed to get back on track, and the Nikkei Index climbed to above the 15,000 level. Everything appeared to be going well.

However, the Japanese stock market abruptly changed direction, registering steady declines week by week, and then last week in fell dramatically, 843.94 points in one day. If that happened to the Dow Jones Industrial Index, such a drop would be considered a panic. What happened?

Before analyzing the situation, one other factor should be mentioned: at the same time that the Nikkei was falling, the value of the yen was rising, at one point reaching the level of ~93 to the dollar. How could such a thing happen, with the government doing everything it could to weaken the yen? The stock market is notorious for exhibiting sudden changes in direction, but the Japanese economy has always been seen to be controlled carefully by the government. Once the government decides on something like a monetary policy, and leaders in the financial and commercial sectors reach consensus with it, rarely is it reversed. So again, why did these things occur?

Call it the result of the operation of the Law of Unforeseen Consequences. Japan might make as many policy decisions as it likes, but the global marketplace is under no requirement to fall in line with them. In this case, it appears that Europe is heading into another recession, which means that it is in no shape to purchase Japanese products, however desirable they might be. And even in terms of desirability, Japan is encountering many problems. Its vaunted electronic industry has hit a rough patch over the last few years, losing tens of billions of dollars due to poor judgment regarding products. Competitors, especially Korean companies like Samsung and LG have leapfrogged over Japanese technology, capturing major segments of the market. On top of that, political friction with China has led to a steep drop in trade with that country. Finally, problems in Japan’s nuclear power industry have yet to be resolved, resulting in continuing imports of liquefied natural gas. This has produced repeated trade deficits, month after month.

All of these factors have created a disturbing environment for Japanese business. Facing such an unstable environment, many major companies have withdrawn funds from the Japanese stock market. That means that they have to find a safe haven for those funds. Where could that be?

How about the Japanese yen?! In years past, US Treasury bonds might have been chosen as a place to park money, but with interest rates so low, that makes little sense. The yen has been strong for a long time, and Japanese business is glad to have it available as a vehicle that acts as a savings account.

So ironically, the government’s strategy backfired: the BOJ bought up corporate bonds, thinking that it would thereby inflate the currency, but those corporations turned around and bought yen, strengthening the currency! Just one more curve in the road that Abenomics has to deal with…

Those who wish to comment on the opinions expressed here may send their thoughts to info@GoWizardry.com. The most interesting responses will be addressed in future postings.

Robert J. Terry

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