With bets against the yen building, the foreign exchange cognoscenti have framed Friday's Bank of Japan meeting as one with potential to break the stubbornly strong Japanese currency.
But even if the BOJ launches another yen-weakening monetary injection to complement the 10-trillion-yen ($123 billion) it let loose in February, Japanese authorities' long-running struggle with an uncompetitive exchange rate will persist as long as their country keeps saving more than it spends. For now, that mismatch is perpetuated by the self-destructive instincts of Japan's aging society--much to the chagrin of yen bears who for many years wrongly predicted demographic change would produce the opposite effect.
These failed bets notwithstanding, there will eventually be a tipping point where Japan's savings surfeit--reflected in its ongoing current account surplus--runs out. It will then need to attract foreign credit to finance government debts currently worth Y1 quadrillion. (Yes, with a "q.") Bond yields, which currently trade at a mere 0.015% for 10-year government notes, will spike higher and the yen will fall. Depending on how quickly the shift happens and, just as importantly, whether it is forced upon the government or engineered by it, this reversal in Japan's financial dynamics could have a highly disruptive impact on the rest of the world. The challenge for investors is to pick the timing.
The one trend that's pushing Japan inexorably toward that moment is the fact that it is gaining retirees at a faster pace than any other country. With ever more elderly folk drawing down their nest eggs, Japan's once impressively high household savings rate is poised to go negative. Earlier this month, the state pension fund said it would this year have to sell Y8.8 trillion in assets, including government bonds, to cover a 37% surge in payment obligations. Japan's government, which runs giant deficits to keep the economy from stalling, won't be tapping "Mrs. Watanabe's" savings for much longer.
Meanwhile, the export squeeze from a strong yen, coupled with a growing bill for oil imports, has ended Japan's once persistent trade surpluses. It has posted a trade deficit in five of the past six months, adding a new minus item to the current account balance.
Yet other forces fueled by societal aging ensure that Japan's external balance stays in surplus and leaves roughly 95% of the government's massive outstanding debt in locals' hands. Most significantly, Japanese companies have raised their saving rate as they repeatedly ratchet down expectations for future growth and pare back investments.
This ingrained expectation for an inevitable, demographic-led decline is similar to the mindset of working-age Japanese consumers, whose deferral of discretionary spending has trapped Japan in self-fulfilling deflationary spiral for two decades. Offsetting both the government's deficits and the shrinking household savings rate, this unwillingness to spend by businesses and consumers keeps the current account in surplus.
The politics of aging only complicates matters. An ever-growing block of retiree voters supports policies that perpetuate deflation and extend the life of their savings.
All of this bolsters the appeal of the yen and of Japanese government bonds for foreign investors in need of a "low leveraged" safe haven. It helps that when Japan's near-zero interest rates are adjusted for expected deflation they pay more on a real, inflation-adjusted basis than the equivalent near-zero rates in the U.S.
Still, this self-destructive cycle must end sometime and when it does the yen will have nowhere to go but down. The question is whether it will be resolved constructively--with a slow, orderly depreciation--or destructively, with a sudden loss of confidence provoking a currency crisis and waves of competitive devaluations around Asia.
The latter scenario could arise if the main contributors to the Japanese savings pool--companies and younger citizens--stop buying the government's bonds, not because they're spending again but because they no longer trust its paper. One possible trigger: the endless procrastination over a much-debated consumption tax leads savers to lose faith and shift their money overseas.
More constructively, the savings rate could fall due to a resumption of economic growth and inflation that encourages spending. Government revenue would grow, allowing it to more rapidly pay down its debt. The yen's decline in that case would be gradual and harmless to Japan's neighbors, which would benefit from improved Japanese demand.
Of course, this would be the intent of any future stimulus actions by the BOJ, which in February set itself a 1% inflation "goal." But the BOJ has frequently hinted at aggressive moves and then backed off. The conservative politics of an aging Japan could stop the inflationist agenda again.
We may simply have to wait for Japan's slow-ticking demographic time bomb to explode. Just be ready to dump yen when it happens.
