Japan confuses appearance and reality: James Saft

February 12, 2013

Feb 12 (Reuters) – A government which sees its role as
driving stock market rallies is one suffering sad confusion
about the difference between appearance and reality.

Japan’s economy minister, Akira Amari, said on Saturday the
government will increase economic efforts in order to drive
Tokyo’s Nikkei index up another 17 percent by the end of March.

“It will be important to show our mettle and see the Nikkei
reach the 13,000 mark by the end of the fiscal year,” he was
quoted by Japan Times as saying in a speech. Japan’s fiscal year
ends March 31. “We want to continue taking steps to help stock
prices rise.”

The Nikkei has already skyrocketed 28 percent in the past
three months, pushed along by an effective devaluation in the
yen which itself was brought on by new policies advocated by the
newly installed Liberal Democratic Party government, including a
doubling in the Bank of Japan’s inflation target to 2 percent.

The theory, and it is correct as far as it goes, is that
higher stock prices may lend animal spirits to the economy,
encouraging consumers to spend and businesses to invest.

It is also, in some respects, like slapping a Bentley
sticker on a Smart Car and thinking the trunk space will
increase.

First, let’s be clear: Japan’s government probably can and
will make this happen, and very likely by driving down further
the value of the yen, thereby improving the competitiveness of
Japanese exporters. Other industrialized countries won’t be that
happy about it, but other than talking down their own currencies
and encouraging their own central banks into increased stimulus,
there isn’t much they are likely to do.

The LDP has been outspoken in calling on the BoJ, to which
Amari serves as a sort of liaison, to be more active in buying
assets, and so we can probably expect more of that, which may
include direct purchases of stocks or moves sufficient to drive
down the yen further.

“A weaker yen has been by far the most effective tool to
generate Nikkei outperformance and it is very reasonable to ask
the question how much further JPY weakness has to go to fully
unwind the underperformance of the last few years,” Steven
Englander, head of G10 foreign exchange strategy at Citigroup,
wrote in a note to clients.

“We stress the Nikkei both because of its wealth effects and
because translation effects for Japanese firms make them far
more profitable and on the margin are as good as fiscal policy
to encourage them to invest. From a political perspective, the
Nikkei-JPY relationship is too much a good thing for Japanese
policymakers to give up.”

APPEARANCE VS REALITY

First, there is just something addle-pated about a senior
government official calling for a specific and spectacular jump
in a major global equity market. It comes across as either naive
or cynical.

Japan does have a series of problems having to do with
deflation and balance-sheet recession, and yes, generating
activity by generating paper wealth will, on the margin, do
something to oppose those forces. Japan’s malaise is not simply
the result of a deficit of animal spirits, it is driven by
demographic issues and, to judge by the example of Sony, an
inability to allocate money to the best ideas.

This mal-allocation of money is demonstrated by the banking
system, which still these many years down the line is loath to
cut off credit from its weakest clients. Artificially driving
the Nikkei up does nothing to make Japanese corporations and
banks better at allocating capital. The products Japan already
produces will be cheaper in dollars or euros, sure, but there
are reasons to worry about the long term.

A jump of 13 percent in the Nikkei will actually simply
shelter Japanese corporations and their shareholders from the
consequences of their decisions, allowing those that are among
the walking dead to continue among us that much longer.

Of course it is easier to magic up stock market gains
through monetary alchemy than it is to reform the banking
system, or to address demographic issues through immigration
reform, so this is where we spend our time.

And it has to be noted that this is exactly the same thing
which is happening in the U.S., though perhaps in slightly less
obvious ways. It is clearly the object of U.S. monetary policy
to increase asset prices and thereby revive the economy.

So, don’t bet against asset-price gains or currency moves,
in the case of Japan a weaker yen. Just remember that the
short-term gains seem pretty slight, to judge by the results
globally, and the long-term costs are potentially high.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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