Japan can’t do anything right.
That’s not a criticism, mind you, but rather an observation of how truly bad Japan’s options are right now. If you want a “risk-free” trade for the remainder of this decade, it would be this: short the yen.
Let’s dig into the ugly details, starting with fiscal policy.
If Japan is to have a viable future, it needs to drastically reduce its annual budget deficits and national debt load — which, at 227% of GDP, is more than double the indebtedness of the United States. But any attempt to do so will take a wrecking ball to Japan’s fragile economy … and perversely cause the debt and deficit to expand rather than contract … thus pushing Japan closer to the edge.
Case in point: Japan raised its national sales tax in April from 5% to 8% in order to plug its budget deficit — which was a gargantuan 7.6% of GDP last year — and its economy contracted at an annualized rate of 7.1%.
Japan is at least tentatively planning to raise the sales tax again next year, from 8% to 10%, though Prime Minister Abe may have second thoughts if Japan’s consumers continue to sit on their wallets.
How bad is Japan’s situation here? 43% of the Japanese government’s current spending is financed by debt sales … and 23% of that goes to meeting the interest payments on the existing debt load. And all of this is made possible by the low levels of Japanese bond yields. Japan’s 10-year bond yields a pitiful 0.58%.
Were Japan’s borrowing costs to rise to levels on par with those of the United States or Europe, debt service would completely overwhelm the budget. Even at current rates, if Japan were to literally cut all discretionary spending to zero, it would still run a budget deficit in order to pay its current interest and social security obligations.
So, Japan’s yields must, by necessity, stay low. Which brings me to the Bank of Japan and monetary policy.
Ben Bernanke fired his proverbial big bazooka when he unleased QE Infinity: bond purchases by the Fed of $85 billion per month for as long as Bernanke and his successors felt it necessary. (Current Fed Chair Janet Yellen will probably finish tapering Bernanke’s QE program next month.)
The Bank of Japan leaves the Fed in the shadows when it comes to quantitative easing. The BoJ buys ¥7 trillion — or $65 billion — in Japanese government bonds every month. But by IMF estimates, The American economy is nearly three and half times bigger than the Japanese economy. So, adjusting for the sizes of their respective economies, Japan’s QE program would be $222 billion in bond purchases per month.
The Bank of Japan is the Japanese bond market now, and for all intents and purposes, the BoJ is directly financing the government.
If that is not enough, BoJ governor Haruhiko Kuroda promised “additional easing” earlier this week “should conditions emerge.” Perhaps Mr. Kuroda plans to use BoJ funds to buy every Japanese adult a new Lexus. Why not? He’s tried everything else.
Meanwhile, Japanese investors are fleeing the island as fast as they can in search of higher yields and more stable currencies. Outflows into foreign shares last month reached the highest levels since 2009.
Might it be possible for Japan, buoyed by a weaker yen, to simply grow out of its problems? Abe styles himself as a market reformer, as Japan’s equivalent to Margaret Thatcher or Ronald Reagan. Could the right mix of pro-growth reforms shake Japan out of its malaise and put it on proper footing?
Not a chance. I addressed Abenomics’ “third arrow” of tax cuts and market reforms back in June, noting that, while cutting taxes is a fine idea, it’s not likely to do much for Japanese business investment. Japan is already sitting on overcapacity and has some of the poorest returns on investment in the developed world.
But the biggest reason for my gloom towards Japan — and why I believe that no set of the “right” policies will help at this point — is Japan’s depressing demographic picture. Japan is the oldest country in the world with a quarter of its population already over the age of 65. Japan’s population peaked seven years ago at 128 million and hasn’t stopped shrinking since — Japan has about a million fewer citizens every year. By 2060, the Japanese government estimates that Japan’s population will have shrunk to 87 million people, and as much as 40% will be older than 65.
At the risk of being morbid, Japan is running up debts today that no one will be around to pay in another few decades. The yen’s recent decline to a six-year low against the dollar has been extreme though orderly. I don’t expect that to be the case for long. When the bond and currency markets finally lose confidence in Japan, I expect to see a total collapse in the value of the yen.
My recommendation? Buy the ProShares UltraShort Yen (YCS) on any short-term rallies in the yen.
Be careful here; whenever the market goes into “risk off” mode and traders unwind their carry trades, the yen can enjoy massive short-term rallies. This is precisely what happened during the 2008 meltdown. So, be patient, and look for good entry points. This is a long-term macro trend that may take years to fully play out.
Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities, but he does plan to initiate a position in YCS within the next month. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.