The yen’s looming day of reckoning

The yen’s looming day of reckoning : As Japan looks set to weaken yen, China must brace for impact

Japan is on an unsustainable path of a strong yen and deflation. The unprofitability of Japan’s major exporters and emerging trade deficits suggest that the end of this path is in sight. The transition from a strong to weak yen will likely be abrupt, involving a sudden and big devaluation of 30% to 40%.

It will be a big shock to Japan’s neighbors and its distant competitors like Germany. The yen’s devaluation in 1996 was a main factor in triggering the Asian Financial Crisis. Japan’s neighbors must have a strong banking system to withstand a bigger devaluation of the yen.

No bubble is sustainable. While the Japanese can always take care of business within, they cannot control the outside world. The country’s Achilles heel is losing trade competitiveness due to the destructive impact of deflation on business confidence and the strong currency itself. When a trade deficit emerges, it signals the beginning of the end.

Japan’s trade balance may swing into surplus from time to time, but the negative trend is irreversible. Japan will face rising trade deficits. That makes foreigners’ views important because Japan would need foreign money to fund its deficit. When foreigners change their views, which they surely will, the yen will crash.

Yen devaluation is likely to unfold quickly. A financial bubble doesn’t burst slowly. When it occurs, it just pops. The odds are that yen devaluation will occur over days. Only a large and sudden devaluation can keep the JGB yield low. Otherwise, the devaluation expectation will trigger a sharp rise in the JGB yield. The resulting worries over the government’s solvency could lead to a collapse of the JGB market. Of course, the government will collapse with the JGB market.

The day of reckoning for the yen is not distant. Japanese companies are struggling with profitability. It only gets worse from here. When a major company goes bankrupt, this may change the prevailing psychology. A weak yen consensus will emerge then.

Serious repercussions on other neighboring countries:

A yen collapse will impact China and South Korea most, just like in 1998. It will trigger substantial weakness in their industries. If a banking system succumbs, the shock can bring down an entire economy, as South Korea’s experience in 1998 demonstrates.

Both China and South Korea have weak banking systems. South Korea’s banking system is one of the most leveraged in the world due to high level of household loans. In 1998, a similar shock sank its banking system that was overleveraged with industrial loans. Now it is overleveraged with household loans. A shock could sink it again.

Overinvestment and a property bubble make China’s banking system very vulnerable to such a shock. Unless China substantially increases the capital in its banking system, a big yen devaluation could cause China’s banking system to sink. China suffers from overinvestment and a property bubble, as Southeast Asia and South Korea did in 1997. In terms of the magnitude of leverage, China’s situation is much worse. Hence, a yen devaluation could wreak havoc to China’s economy.

So what do ATS members think of this assessment?

Again, like my other thread this comes from Andy Xie, an independent economist from Shanghai who apparently called all four financial crises including the Japanese asset bubble of the 1980s, the 1997 Asian financial crisis, the deflation of the dot-com bubble and the U.S. subprime mortgage crisis.

If this scenario unfolded, it would certainly have far greater adverse impacts beyond the Asian economies the economist refers to here. China being one of the few main drivers of global economic growth remaining, if that economy has a hard landing, then what resources, strength and resilience has the rest of the world economies have to counter a regional collapse, should it come to it? I think another event of magnitude to the Lehman Bros bankruptcy would be quite disastrous on a global scale, given the Eurozone sovereign debt crisis and their fragile economies, weakening economies elsewhere around the world, and reduced policy tools for dealing with financial and economic crises.

Japanese manufacturers remain gloomy over high oil prices, the strong yen and weaker growth in Asia, according to a central bank survey that defied expectations that business confidence is improving
Although the yen has fallen slightly after monetary easing by the Bank of Japan in February, large manufacturers are pessimistic over its likely future course.

Large manufacturing companies assume an average exchange rate of about 78 yen per dollar for this fiscal year that started April 1 compared with current rate of nearly 83 yen per dollar.

The survey forecasts business sentiment among large manufacturers to rise only marginally to minus 3 over the next quarter. Medium-sized and small manufacturers expect business conditions to deteriorate.

As long as the large manufacturers are at a low level ... it is unlikely that the small and medium-size business activity will recover in the near future.

It seems that the world ecconomy is a ricketty bridge over a boiling lake of laver.
There is no safe haven in this environment. Japan, china the Erozone and the US
all have major structural issues. if the slowing of the erozone ecconomies impacts
on china too badly then were in for a very bad time of it. if japans 200+ GDP to debt rate
causes a crash then we are also in a very bad way. I think we will see the major crash
in the next decade, (not very precise )but we just keep seeing more debt being introduced into
the system, when does all this debt come home to roost?