When officials talk down the national currency to stimulate exports and economic growth there's a risk that falls can get out of hand, hence the verbal intervention by Japanese finance minister Akira Amari that the Japanese yen (JPY) has gone far enough. The trouble is that Japan's fundamentals are so dire that this may only be the beginning.
JPY's descent versus the U.S. dollar was stabilized above key support around 100. But that's not likely to last as the U.S. Federal Reserve is talking more enthusiastically about stopping its quantitative easing program. But longer-term, Japan faces a fiscal crisis as it can't balance its books and that could prove to be a sledgehammer blow for its currency
The numbers on Japan are ugly. Government expenditure is 46% funded by borrowing adding to the already huge debt pile running at over 240% to GDP. Meanwhile the savings rate is falling with nearly a quarter of government revenue being used to pay interest on its debt in an environment of very low interest rates.
The new government headed by Prime Minister Shinzo Abe thinks it will turn the ship around with aggressive quantitative easing and fiscal stimulus, but may end up making the situation worse.
How much further for USD/JPY?
Japan has tried all this before and it didn't reverse two lost decades of growth. Repeating the exercise on a grander scale is unlikely to create much more than a temporary up-tick in GDP growth.
Japan can't grow sustainably any more. The country's population isn't just aging, but actually set to shrink dramatically and these two trends are well entrenched. Nearly a quarter of Japan's 128 million population is over the age of 65. By 2060 that is forecast to rise to 40% with the population declining to 87 million. Household consumption makes up around 60% of Japan's GDP and that key segment is shrinking and so therefore the economy will to.
A crisis in Japan is inevitable
A succession of weak governments looking to keep voters on side did not prepare the country for this outcome and an inevitable fiscal crisis looms as expenditure soars while tax revenues shrink.
A financial crisis is almost certainly in the cards for Japan, and it is just a question of timing. Unfortunately, the government may have fast forwarded that date.
The risk of actually stimulating inflation is that it will erode consumer spending power. That's certainly been the experience of the U.K. where the pound has been pushed lower on a tidal wave of QE leading to imported inflation. Higher inflation could lead to higher interest rates, notwithstanding the concerted bond buying efforts by the Bank of Japan. A rise in interest rates would add to the government's burdens.
The other problem is that when it becomes apparent that these stimulus efforts haven't worked — that will probably take a few years — Japan's debt pile will be even bigger. What will follow is another round of credit downgrades from the main credit rating agencies, a crisis of confidence in Japan's financial position possibly leaving the Bank of Japan as the only buyer of JGBs.
The Japanese government will eventually default on its debts and many of its social obligations. It's just a case of whether it does it via inflation or by ceasing to pay interest and by not redeeming some of its paper. The long-term outlook for JPY is therefore extremely bearish.