22 years ago, Japan was a completely different economy. The Nikkei, the primary index for Japanese stocks, had reached its all-time high of 38,957.44 on December 29, 1989. Real estate and stock prices were soaring.
Of course, we know what has happened since: two decades of persistent deflation, high unemployment, and a Yen that keeps getting stronger in spite of the Bank of Japan's most determined efforts to devalue the currency. In this the final week of June, 2012, the Nikkei is trading at around 8,730 -- less than 23% of its all-time high.
Finally, though, I believe the situation is changing. No, I don't think the Japanese economy is recovering; just the opposite: I think deflation is reaching its terminal point, upon which a crisis of confidence will manifest in the currency and hyperinflation will be unleashed. The result of this could be a drastic devaluation of the Japanese yen, and a rise in the Nikkei and real estate -- at least in nominal terms, although I doubt they will increase in real terms (meaning I doubt any rise in the Nikkei or Japanese real estate will outpace the rise in the cost of living that comes from a drastic currency devaluation).
The reason Japan may be at a point where its currency could begin weakening significantly, leading to a classic hyperinflation scenario, are as follows:
- Twin deficits. Japan is now running budget and trade deficits. In other words, the Japanese government spends more than it takes in -- meaning it runs a budget deficit -- and the country also imports more than it exports (a trade deficit). Japan's trade deficit is a fairly recent development, borne largely out of the Fukushima meltdown that led the country to shut down its nuclear reactors. The shutdown of these reactors forced the country to import its energy, which in turn led to a growing trade deficit. So long as the condition of twin deficits persists, Japan will face greater risk of needing the Bank of Japan to print money to make up for its budget deficit while also having the market naturally sell yen in the course of international trade.
- Extreme debt levels. Japan's debt/GDP ratio is approaching 2.2 -- the highest of any major economy in the world. Such high levels of debt go hand in hand with chronic budget deficits, and create a situation where it becomes increasingly likely that the only way out is for the Bank of Japan to simply print yen. This action could quickly lead the market to lose faith in the Yen, and thus a crisis of confidence in the currency is borne. This is always the way hyperinflation comes about; the market loses faith in a currency because of the politics behind how it is managed, and the currency experiences a sharp decline in value as a result.
- Demographics. The population of Japan is aging at an alarming rate. This means the country's labor force and tax force are declining, which means its twin deficit problem will be even harder to solve; a reduced labor force means its harder to produce goods and services to export and that more will need to be imported, while an aging population increases the likelihood that government subsidies will be difficult to cut. The less productive Japan's economy becomes, the less the Yen gets used; the less it gets used, the less people have a need to keep it. In this way, the demographics problem can add to the list of reasons why confidence in the Yen can decline and significant currency devaluation can result.
I believe the technical situation is now beginning to favor a long USDJPY position as well. Below is a monthly chart of the pair; I believe a reversal base could now be forming. Based on the fundamental situation the yen is facing and the increasing likelihood of hyperinflation, I consider it reasonable that USDJPY will head back to 160 -- where it was in 1989 when the Nikkei reached its all-time high.
