Japan’s fiscal cliff

published 2 November 2012

Investors are becoming more bearish on the Japanese yen. Last week, market data revealed that for the first time in nearly six months more bets were placed on the yen falling in value than rising. Could this be the beginning of a prolonged fall?

There are plenty of reasons for pessimism. But for a long time, the yen has been seen as a safe haven a least-worst option away from the financial mess plaguing Europe and the US. Four years ago, a dollar would have bought you 97. It now buys around 80.

This has made exports more expensive, which is bad news for an economy weighed down by debt for the last 20 years. The Bank of Japan has tried to help lower the yen's value by printing money but most of the West is playing the same game, trying to export their way back to economic health by devaluing their currencies and making their goods cheaper on international markets.

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They are also printing more money than Japan and in doing so are helping to keep the yen high. Currency speculators are betting that the Bank of Japan will announce more money printing and start selling yen again.

Meanwhile, Japan's dire financial position might do the job for them. Economist Gary Shilling, on Bloomberg, and academics Peter Boone and Simon Johnson in The Atlantic, are bearish on the yen's long-term value. Both argue that Japan is drowning in debt, which will become more difficult to pay interest on, let alone pay back. Nearly half of the government's income is taken up by debt interest.

Plus, it continues to spend more than it takes in the deficit will be nearly 10% of GDP this year. Worse still, the economy is stalling and trade surpluses have become deficits as exports have slumped. But the ability of the government to raise income is under pressure. The population is declining and costs more money as it gets older.

For years, this wasn't a problem as citizens bought bonds to finance government spending and borrowing. But savings rates have plummeted. People talk about America's fiscal cliff', but Japan faces one too.

Like lots of problems in financial markets, these issues have been known about for a long time, but the future is always somebody else's problem. If the prophets of doom are right, a dollar-yen rate of 80 could be as high as it gets. Japanese exporters will be hoping it is.