Despite all the talk about the U.S. fiscal cliff and debt ceiling, developments in Japan are shaping up to be 2013's biggest story for financial markets.
The yen has now fallen over 13% vs. the greenback since mid-November and traded below 90 to the dollar on Friday -- the first time since mid-2010. Shares of Japanese multinationals such as Toyota (TM) and Sony (SNE) have surged in reaction as a weaker yen makes them more competitive vs. their global competitors.
The yen’s weakness is a direct result of the campaign promises and policies of new Prime Minister Shinzo Abe, who won a landslide election in December.
Thanks to a strong majority in Japan’s parliament and the pending retirement of three top Bank of Japan executives, Abe has a great opportunity -- and the political capital -- to live up to his promise to reinvigorate Japan’s economy by weakening the yen and embark on a massive stimulus program, according to Axel Merk, president of Merk Investments and manager of the Merk Funds, which has about $650 million of assets under management.
“The Japanese are known to talk, not act: That’s going to change,” Merk says.
The yen has become known as the “widow maker” for its historic propensity to punish those who’ve tried to short it. Similar to the dollar, the yen has enjoyed "safe haven" status during times of crisis. Repeatedly proven reports of its demise have been premature. But Merk believes this time really is different.
“The yen is doomed,” he says. “We think the yen is going to drop substantially this year [and] eventually is going to be worthless.”
‘Worthless’ seems a bit hyperbolic and overly emotional. But Merk’s 2013 outlook piece cites the following fundamentals to support his forecast of continued weakness in the yen:
- Abe’s government will appoint the three top positions at the Bank of Japan, as the governor and both deputy governors retire. Recent appointees have already been more dovish. Japanese culture is said to prefer talk over action, but the time for dovish talk may finally be over.
- Despite its dovish reputation, the Bank of Japan barely expanded its balance sheet since 2008; of the major central banks only the Reserve Bank of Australia has been more hawkish.
- Japan’s current account is sliding toward a deficit. That means, deficits will start to matter, eventually pushing up the cost of borrowing and making a 200%+ debt-to-GDP ratio unsustainable. (As you'll see in the accompanying video, Merk is quite animated on the subject of Japan's deteriorating current account deficit and views it as key to a bearish view on the yen.)
- Abe’s government is as determined as it is blind. Abe believes a major spending program is just what Japan needs. As far as the yen is concerned, Abe may be getting far more than he is bargaining for.
“The good news is we don’t think there’s a European crisis,” he says. “There’s a shifting global crisis and it’s shifting from the U.S. to Europe to Japan.”
Regular viewers may see a pattern here. As you can see in the "related" links here, several guests have been spinning a variation of the same story in recent weeks: The yen is going to keep getting weaker and Abe’s government – along with global markets – should be careful what they wish for.