Currency traders were stunned last week by aggressive action from Japan’s central bank. The Bank of Japan embarked on a bond-buying program that, by one measure, is twice the size of the extraordinary moves by Ben Bernanke and the Federal Reserve in the United States. The BOJ’s move is an effort to shock the Japanese economy out of more than a decade of sluggish growth and deflation.
Jens Nordvig, global head of currency strategy at Nomura Securities, was one of many market watchers surprised by the strength of the Bank of Japan’s move. “The amount of money that they’re injecting into the system is unprecedented relative to the size of the economy,” he says.
It wasn’t a surprise that the central bank took action. Prime Minister Shinzo Abe had made clear his intention to provide strong stimulus to the economy and recently installed a new president at the Bank of Japan who backs his approach. Nordvig says the financial markets expected a stimulus comparable to the Fed’s action.
What they got was twice as large — and that prompted an outsized response.
‘A Big Sentiment Shift’
“It’s being received in the financial markets in a way that it’s almost the entire focus globally, from the U.S. to Italy, Turkey to Brazil,” Nordvig says.
For instance, long-term interest rates fell sharply in the U.S. and stocks in emerging markets strengthened as the Japanese central bank flooded the financial system with yen. Japanese stocks also skyrocketed and the country’s currency tumbled to four-year lows of about 100 yen to the dollar.
Nordvig says that devaluation of the yen should help Japan move from deflation toward the goal of about 2 percent annual inflation and boost economic growth by encouraging spending.
“If you know prices are going to rise in the future you’re more inclined to spend now than wait, and that’s the basic mechanism through which you can bring forward consumption and investment,” he says.
And while it’s too early to tell for sure, Nordvig says, it appears the policy is working.
“They’ve managed to engineer a big sentiment shift — big changes in asset prices and even on inflation expectations — which is at the core of what they’re trying to shift; there we’re starting to see some upward movement,” Nordvig says.
Sung Won Sohn, professor of business and economics at California State University Channel Islands, says Prime Minister Abe’s policies are also beginning to have some effects.
“Some of the Japanese companies such as Honda and Toyota, they’re reporting fairly good sales as a result of the yen depreciation making their products more competitive — at the expense of other countries such as South Korea, for example,” Sohn says.
Competitors Watch Closely
And there’s the rub. While a weaker yen might help Japan’s economy, it’s hurting the economies of some of its neighbors, particularly in Asia. Sohn, who just completed a visit to Japan and South Korea, says the countries compete head-to-head on seven of their 10 largest exports.
“Put yourself in the position of the South Koreans,” Sohn says. “They are saying, ‘We are losing market share; should we engage in competitive devaluation?’ And I wouldn’t be surprised if at some point they say, ‘We have to defend ourselves against the Japanese depreciation of the yen.’ “
That weakening of the yen has countries from South Korea to Brazil concerned about the specter of a currency war, where countries devalue their currencies to make their exports cheaper. But so far, the powers that be — like the U.S., the G-20 and the International Monetary Fund — have defended Japan’s action.
On CNBC Wednesday, IMF Managing Director Christine LaGarde voiced her support. “They’re doing what they can to kick-start growth when there has been none for a long time … and to make sure that credit flows into the real economy so that investment can start again,” she said of Japan’s actions.
But while some see a return of growth to Japan as a positive for the world economy, despite the damage some of its direct competitors will suffer, Sohn disagrees.
“I don’t think Japan is going to be really the swing factor as far as the global economic activities are concerned,” he says.
That’s because with an aging society and no population growth, Japan’s ability to expand fast enough to be a global economic engine is limited.