The Yen's Impact on the Recovery of Japan & the World EconomyMarch 20, 2012
Phoebe Donham, Managing Director, Head of FXEM Macro Sales, Morgan Stanley
Jens Nordvig, Head of Fixed Income Research, Americas and Global Head of G10 FX Strategy, Nomura
Ellen Zentner, Senior Economist for the US, Nomura
Sara Eisen, Reporter and co-host of “Bloomberg on the Economy” on Bloomberg Radio
Japan Society joined with the Women's Bond Club to present a panel of three distinguished finance experts who discussed the impact of the yen's strength on Japan and on the global economy.
Sara Eisen of Bloomberg Radio, who moderated, opened with questions for Ellen Zentner, Senior Economist for the U.S. at Nomura:
The March 11 disasters a year ago obviously had a tremendous impact on the Japanese economy. Where are we right now?
"Although the government has been criticized for being slow to respond in the reconstruction efforts, the private sector has been amazingly resilient," Ms. Zentner replied. Japanese consumers didn't pull back as observers had feared. Companies "showed an amazing amount of innovation and creativity in dealing with the electric outages," adapting production schedules to deal with rolling blackouts and seeking out alternative energy sources. Overall job creation in 2011 was positive. "You could clearly see a dent to manufacturing"—as indeed was the case in the U.S.—but in other industries, Japan continued to add jobs.
This was felt economically all over the world. What was the impact on the U.S.?
American auto sales dropped off very sharply in May and June due to the supply chain disruptions, Ms. Zentner said. The shortages hurt U.S. production so much that "by June, the Toyota Prius was down to a one-day supply, and the waiting list was a mile long."
The United States had bounced back: by September 2011, Japanese motor vehicle production in the U.S. was back to what it had been a year earlier. Nevertheless, in the second-quarter of 2011 "we saw the motor vehicle sector shave off about 0.7 percentage points from GDP growth in the U.S. That is discomforting when you have an economy that’s growing around 2 percent and you’ve got a drag that big."
Right after the earthquake, as automakers scrambled to find substitute sources for parts, they found that many German parts, for example, depend on Japan for various components—"and so it always kept coming around full circle, and you realize where those weak links are."
The yen reached a post-World War II high in the wake of 3-11. What has been the fallout in Japan and also in the U.S.?
This has in essence added insult to injury, Ms. Zentner said. One response by Toyota has been to announce that it will move production of the Highlander SUV to its existing factory in Indiana, adding some 50,000 units and 400 jobs at the plant. The impact will be all the greater because of the strong multiplier effect in the industry: for every job created in motor vehicle manufacturing in the U.S., three and a half jobs are created in other businesses.
In addition, Japanese automakers will be moving some production to China to satisfy the local market. Nissan has said it will invest $2 billion in northern Mexico. "We’re going to see the overall stamp of auto manufacturing at least change after this event—the long-term footprint will sort of spread out. More demand will be met by local manufacturing."
Ms. Eisen's next question was for Jens Nordvig of Nomura:
Right after the earthquake, the yen strengthened, and it's remained high until very recently. What's happening?
The main factor isn't Japan, but Europe, Mr. Nordvig said. Japanese investors began to sell their Spanish and Italian bonds, and "as we got further and further through the European crisis, they started to sell their French bonds, their Belgian bonds, and in November they started to sell their German bonds too." This repatriation flow "back into Japan, typically into JGBs, was very important" in producing a "period of extraordinary yen strength that is hard to explain based on Japanese factors alone."
As the crisis in the EU has eased somewhat, this flow has stopped. "Japanese investors are starting to buy the highest-quality European bonds again, and that is generating some yen selling." There's been better news in the U.S. on retail sales and payrolls. In Japan, the BOJ "managed to surprise the market in a more dovish direction," with greater than expected asset purchases, and the emergence of a trade deficit has "generated sort of a renewed appetite to actually sell the yen both from domestic and international participants in the market."
Some market professionals wonder if Japan is going to face a debt crisis similar to the United States. Is that a ticking time bomb?
The domestic investor base can absorb the financing requirements of the next couple of years, "but if I do think further out," into 2014 and 2015, "we start to reach that tipping point," Mr. Nordvig said.
What's your one-year forecast for the yen?
The U.S. shift in yields is probably temporary, Mr. Nordvig said, so the yen, which is at 83 now, is probably "going to spend most of the year" in the low 80s. Beyond that, "the ongoing trade deficit is going to be a gradual drag, and that means that next year we are probably going to trade through 85 and hit higher from there."
Ms. Eisen asked panelist Phoebe Donham of Morgan Stanley:
Tell us about the corporate response in Japan to the 3/11 disasters and the strengthening yen.
"It's important to note that yen strength has definitely not just been a tsunami-related repercussion at all. This is actually something that the Japanese economy has been grappling with for four-plus years," with floods in Thailand also causing supply chain disruptions, and weakened demand from the U.S. and from larger trading partners in Europe, Ms. Donham said.
Japanese corporates have entreated politicians to do something about the strong yen, and in turn, politicians have put pressure on the BOJ. "In terms of real levers," however, companies essentially have only one recourse, which is to relocate their factories to the places where their customers live.
"Unfortunately I do see the trend continuing, at least for now," she said. It's one thing for nimble companies to deal with yen strength that lasts for half a year or 12 or even 18 months, but longer periods demand "some real fundamental changes in the way in which they are looking at their own future within Japan."
The 10 percent drop in the yen isn't enough; the exchange rate "needs to be through the high 80s, through even into the mid-90s, I think, for corporate Japan to start to really mitigate some of the corrosive effects that the strong currency has had for the past four years."
How do international investors and companies view the yen's impact on doing business in Japan?
The manufacturing gauge, which is volatile but "a good judge of Japanese corporations," declined "to a new multi-month level, at minus 11," Ms. Donham said. It's been a frustrating time for international investors, who "have generally gotten the currency bet wrong."
Given a strong currency, exporters with cash and a strong balance sheet can make international acquisitions, she said. Asahi purchased Independent Liquor of New Zealand for $1.3 billion and Kirin bought a controlling stake in the Brazilian brewer Schincariol for $2.6 billion; altogether in 2011 corporate Japan made almost $70 billion in overseas asset purchases, close to twice the 2010 figure.
"One thing that is fundamentally different" between the U.S. and Japan "is the speed at which the banking sector issue has been dealt with and the sector has been recapitalized," Mr. Nordvig commented. The U.S. worked through its stress tests and recapitalized within a two-year period, whereas in Japan the banking system went for more than a decade until capital was finally injected.
Questions from the audience followed:
What was the catalyst for the BOJ's move in February to tackle the deflation problem, and are there any legs to this?
"Our take is that the very strong yen did have an impact in terms of triggering this more aggressiveness in February, but we don’t see it as the first step in a dramatically new policy from the BOJ," Mr. Nordvig said.
With two cabinet posts opening up shortly, some analysts think that Prime Minister Noda will press "to get more activist members into these spots," Ms. Donham said. "But that's still a big question."
A lot has been said about the shutting down of all the nuclear plants in Japan. Could you comment on the energy sector and its impact on the yen in the near term?
"Part of the issue has been a much higher cost of fossil fuels and imported fuels," which is a further burden on corporate Japan, Ms. Donham said. "Certainly we have seen commodity prices on the rise globally." TEPCO is considering a fee increase of up to 17 percent, perhaps imposed on large corporations only, though the scope may be expanded. "There are still a lot of unknowns... and I don't really think that Japan has a game plan" to address the increases in fossil fuel costs.
Is the dollar/yen moving with the price of oil, now that Japan has decreased its nuclear energy capabilities?
The general data don't really show this, but "over time it should be more like that," and in fact when you break out energy from the rest it's very clear, Mr. Nordvig replied. "The energy deficit has just exploded" due to price increases and the need to switch to alternate sources due to the nuclear plant shutdowns. LNG imports "have risen by 50 percent, so it's clearly a substitution effect."
How strong is the U.S. economy, and what will the Fed do to prevent the yield curve steepening, particularly when Operation Twist, its program to sell short-term Treasury bonds and buy long-term bonds, ends in June?
The expansion is slow, but not anything outside the typical post-financial crisis growth patterns for developed nations, Ms. Zentner said. Households shed debt, and then the public sector starts to retrench; "in fact, we saw a big hit to fourth-quarter GDP just from the wind-down of troops in Iraq." The housing market, which typically accounts for 0.8 percentage points of GDP expansion, has contributed precisely zero this time around. "It's going to keep the Fed in an accommodative stance for a long time."