The global economy is fragile, markets seem to be in turmoil, China certainly looks like it’s slowing down and low oil prices have made people nervous the world over, so Japanese Prime Minister Shinzo Abe saw no other option but to step in with his continued aggressive measures to buoy the domestic Japanese economy.
The yen has dropped from 75 to the US dollar to as low as 125 since Japan started embarking on its rock bottom interest rate policy (112 at time of writing), and massive government stimulus has pushed Japanese debt over the one quadrillion mark. Whether we’ll see a much stronger Japan in the years ahead remains to be seen, but it is likely that, after this recent foray into negative interest rates, some sectors will profit and the yen will continue to weaken.
Tourism and real estate are two sectors expected to benefit in the near term. Because holiday makers will get more of a yen-bang for their bucks, the weak yen will continue to entice those foreigners wishing to experience Japanese culture up close and personal. This in turn is already helping to finance a boom in new resorts, tourist attractions, hotels and shopping malls.
Furthermore, Japanese investors will be even more likely to avoid conventional investments such as government bonds (where the 10-year bond is paying a measly 0.7%), turning their attention instead to real estate as they search for higher yields.
Persistently low interest rates, as we have learned in the west, hurt savers and make people poorer. They also encourage excessive risk taking. In Japan’s case, there is far too much money sitting on deposit, and inflows into other conventional investments are nowhere near the levels the economy requires to permit the government to ease off on its money printing.
But it is unlikely that the rate cut was aimed at the frugal citizens of Japan, rather at the more miserly financial institutions. With the rate cut, institutions will now have to pay the government if they wish to deposit money in amounts that exceed the central bank’s stated minimums. In theory, this will stop the banking sector from building up reserves, and encourage banks to begin lending again – something which has been lacking in the Japanese economy for many years. A healthy economy needs some leverage in the form of loans to individuals and to businesses and without that additional boost to the economy, the central bank is unlikely to achieve its inflation goals.
With more money flowing into the financial system in the form of loans, businesses should be able to expand and employ more workers. Those workers, in turn, will be able to take out loans themselves for things such as houses and cars. This is classic velocity of money theory, and it is what drives any market economy.
Unfortunately, Japanese companies have become accustomed to deflationary pressure in the domestic economy, which means if a company borrows money – and then prices continue to fall – their revenue suffers and they struggle to repay the loan… even if the cost of borrowing is essentially zero.
Although this current rate change only took effect on February 16, some analysts are looking even further ahead and believe that additional cuts are imminent. Shinzo Abe has certainly proved that he has the stomach for it, and is not scared to do what it takes to get the economy up and running.
But with debt already exceeding one quadrillion yen, the longer the Japanese government continues with its policies, the more sense it makes for foreign investors to stay away from yen-denominated assets – especially Japanese government bonds.
But for anyone looking to Japan for investment opportunities in some of the sectors in this article, such as real estate, they must weigh up the benefits of their investment against the possibility, or indeed the likelihood, of a further weakening in the yen.
Any existing or would-be investors in Japanese assets who fail to educate themselves on how they can hedge against any further slide in the Japanese currency may soon find their portfolio resembling those Japanese interest rates – negative.
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