I’m not an expert on what I’m going to talk about, so if you find some stupidity please correct me in the comments, thanks!
When the housing bubble crashed in the United States the chain reaction started to affect other countries, specially those that had their own local property bubble, like Spain or Great Britain. During the first months the Japanese economy didn’t seem to be affected and Japanese newspapers were bragging about how the Japanese economy was quite strong against the global financial crisis, arguing that the solid foundations of the Japanese bank system and the exports were keeping it safe. Another argument was that nowadays in Japan there’s no housing bubble at all because real state prices are still going down after twenty years falling continuously.
Even the Japanese Prime Minister said last year that Japan was going to be a great example on how to deal with the global financial crisis. He had to eat his own words after the yen started to skyrocket against the euro and the dollar, and the collapse of Japanese exports. Last June with 1 euro you could buy 169 yen, but in just two months the value of the yen shot up and at the end of September with 1 euro you could only get 120 yen. Something similar happened with respect to the dollar but the change was not that abrupt.
Euro/Yen exchange rate from 2001 until the end of 2008. Notice the downfall of the euro in respect to the yen.
Dollar/Yen exchange rate for the last five years. The fall of the dollar in respect to the yen is big but not as deep as the euro fall.
A direct result of having such a strong currency (apart from the fact that if you come to Japan everything will be much more expensive for you 😉 ) is that Japanese products are now less competitive (i.e. more expensive) in the global marketplace. Suddenly, from a European or American point of view, Japanese products are now 30% or even 40% more expensive in just a few months. If we add to this the dwindling global consumption we can see that Japan, one of the major exporters in the world, is in big trouble. For an economy based on manufacturing and exportation like Japan, the damage caused by such a sudden change in the value of the yen is lethal. In this graph we can see how Japanese exports start to crumble down just after two months since the rise of the yen.
Japan exports shrink (more than 50%) months after the rise of the yen.
The yen goes up, Japanese products lose competitiveness, exports go down, sales of a lot of Japanese firms sink. For example, Sony sales have gone down 70% and Toyota sales are at 35 years ago levels. Toyota, Nissan and Honda have reduced their car production around 50%. Sony has also drastically reduced its production and has had to cut down jobs massively for the first time in its history.
Other Japanese corporations like Panasonic or Canon have massively cut down jobs as well, something that didn’t even happen in the last Japanese financial crisis. In Japan the ship sinks many times with all the passengers aboard before they throw someone overboard, but it seems that the attitude is changing and more and more people are finding themselves unemployed. Last estimates say that the unemployment rate will exceed 5% at the end of the year.
Toyota’s share price over the last five years.
Nintendo’s share price over the last five years.
Sony’s share price over the last five years.
In other words, the yen’s rise is mostly to blame for the current recession in Japan. But, why did the yen’s value went up all of a sudden?
One of the reasons is that when international investors see the big problems of the global economy, and even though Japan faces recession, they still see Japan as a stable and safe economy. Because the Japanese economy goes up or down little by little investors see it as a safe haven. Moreover Japan is still the world’s largest economy after the United States and its banking system has limited exposure to the subprime crisis. As a result, many investors decided to move their money reserves from euros and dollars to yen, causing a rise in the yen’s value.
However, the main reason behind the skyrocketing yen’s value was the proliferation of the yen carry trade. The term carry trade refers to borrowing money in countries with very low interest rates and lending it or investing it in countries with high interest rates, usually earning a big return. Here is a simple example (ignoring banking fees, taxes and so on):
- Say 1 euro = 150 yen.
- We borrow 1,500,000 yen from a Japanese bank with a 1% annual interest rate.
- We exchange that money to euros, obtaining 10,000 euros.
- Then we reinvest those 10,000 euros somewhere in Spain with a 5% annual return.
- If at the end of the year we give the money back to the Japanese bank we will have earned 400 euros.
- We are earning money out of thin air!
- Imagine the same picture but with 1 million euros, we would earn 40,000 euros annually!
- Imagine the same picture but with billions of euros!
During many years global investors saw the yen carry trade as a steal. Hedge funds, investment banks, governments and Co. saw the extremely low Japanese interest rates as a bargain. They borrowed billions of yen and exchanged them into their local currencies in order to make easy money. Some sources say that at the end of 2007 more than half a trillion dollars were out of Japan in carry trade operations. The “good” thing about this flee of capital was that the yen’s value went down for years and benefited Japanese exporting companies, for example Toyota had the best year in its history in 2007. But all those billions had to go back to Japan as yen at some point, it was an authentic time bomb that eventually exploded last year.
That money had to go back to Japan one day sooner or later, it had to be exchanged from dollar, euro or other currencies to yen. That day arrived when the subprime mortgage crisis unfolded in the United States, when investors suddenly lost their interest in the carry trade and started to prefer liquidity instead of carrying on investing. They stopped borrowing money from Japan and now they just give back the money that they borrowed in the past, which is continuously converted into yen, causing its value to increase until levels not seen in many years, and consequently affecting Japanese exports as I wrote at the beginning of the article. Another of the causes of the carry trade unwinding is that the interest rates around the world are at rock bottom; in fact in United States they are almost as low as in Japan. And if the margin between interest rates is small then the carry trade operations don’t yield big profits, as you can deduce from the example above. A lot of money is moving back to Japan and global investors are not interested in the yen carry trade any more. If you want to look further about the carry trade this is an excellent article written by a Harvard professor.
Such a sudden change in the yen’s value and the exports huge fall has enormously affected the Japanese GDP:
Notice the huge fall in the last quarter.
After some years trying to recover from its own property bubble, with interest rates close to zero, inflation close to zero and an annually GDP growth between 1 and 2%, the Japanese economy will once again enter recession during this year and the small inflation seen during the last years will turn into deflation. The funny thing is that Japanese people are not worried at all, they are used to live with an economy where the prices don’t go up and the salaries haven’t increased much for the last 20 years, they are used to live in a financial crisis.
When I ask my Japanese friends about the financial crisis they look at me with a poker face and say that it doesn’t matter in daily life, that they are used to it, that they are used to live in the no-economy (Fukeiki=不景気). Actually, to say the truth, after some years living in Japan I don’t care much if the prices don’t go up or the interest rates are close to zero. At the beginning I was shocked, specially when I arrived here during high inflation times in Spain and I was used to see prices go up every year. We will see what happens in Spain and other countries, Marc says that in Europe we will face a deflation or maybe the totally opposite, a huge inflation. It would be funny to see how the different societies used to live under inflationary times see prices go down.
The following picture (which I did with my “awesome artistic skills”) sums up what I’ve written until now about the main causes of the current Japanese financial crisis:
The point is that the American economy is looking every day more and more like the Japanese economy, and a lot of people wonder if the United States will commit the same mistakes that the Japanese did while trying to solve the financial crisis of the last decade. Up until now the measures taken in United States and elsewhere have been very similar. For example, many people criticized Japan for using a lot of public money to stimulate the construction of public works as a fast way to create employment and move money around the country, however now EVERYBODY is doing the same!
In Japan there are now bridges that cost millions that lead to islands where only two 90 year old men live, but the construction of those bridges generated temporary employment. Personally, I think that this way to create fast employment is quite stupid. Krugman even starts to see with good eyes the lost decade of Japan, praising that even during a huge financial crisis Japanese citizens didn’t lose their jobs:
And given what the next couple of years are likely to look like, Japan’s lost decade — yes, growth was slow, but there wasn’t mass unemployment or mass suffering — is actually starting to look pretty good. We may or may not be about to face our own lost decade, but the sheer misery millions of Americans will face in the near future probably exceeds anything that happened in Japan during the 90s. I still hope we can do better than the Japanese did, but it’s not at all obvious that we will.
Many banks and big corporations in Japan went bankrupt, many politicians had to step down, the Nikkei stock index went down from levels around 40.000 to levels under 8.000 (and never recovered); the economy suffered but the citizens were the less affected. Japan faces the current financial crisis with more experience than anyone but the future doesn’t seem very bright; ask the drunken ex-minister of finance what he thinks about Japan’s debt or the graphs that show the dwindling Japanese population like this:
Most long-lived population in the world
I hope I have clarified things a little bit and now you have a better grasp of how is the financial crisis affecting Japan. And remember that we’re in times of opportunity!
I would like to dedicate this article to Fer Martín who has just started a new phase of his life in Barcelona and to Marc Garrigasait who encouraged me to write about this topic.
Sources:
- Japan’s inflation the lowest in the world (Spanish)
- Toyota Halves Output Amid Poor Auto Sales (English)
- Bank bailouts (Spanish)
- The crazy world in graphs (Spanish)
- The Japanese economy and future growth prospects (English)
- Another lost decade? (Japanese)
- Japan Vows More Spending, Backing American Stance (English)
- Bank of Japan to Raise Bond Buys (English)
