The writer is an adviser to Monex Group and the Japan Catalyst Fund
Currency markets move in the direction of maximum pain. I learned this insight from a hedge fund manager who bet against the pound 30 years ago on expectations that the UK would be forced to leave the European Exchange Rate Mechanism.
Japan is now close to its pain point. While a parabolic overshoot from current levels of around ¥148 against the dollar towards ¥155-60 is still possible, the balance of risk is now asymmetric. In my view, by this time next year, the yen is poised to be back up to ¥115/120.
Why? It is because both global and Japanese corporate leaders are beginning to invest in Japan. The price signal sent by ¥140-150 is simply too strong.
It is easy to show Japan is cheap. A Big Mac costs ¥410 ($2.75) in Tokyo versus $5.15 in the US, so at current exchange rates you get twice as much for your money. Average Japanese annual wages are down to ¥4.4mn ($30,000 at current exchange rates), according to OECD data. That is less than half the nearly $75,000 average in the US for 2021.
Japan buying has now started. The real question is no longer when the buying will start — leading companies like robot maker Yokogawa Electric, cosmetics group Shiseido and global tech leader Google have recently announced significant inward investment plans. It is whether prime minister Fumio Kishida will seize this unique opportunity. If, as I suspect, he helps reinforce an inward investment surge by a pro-growth, pro-deregulation agenda, Japan’s growth potential is poised to rise.
Already, yen weakness and inflation have begun to attack Japan’s foremost structural problem — too many zombie companies. About one out of 10 companies in Japan has not been able pay its debt service costs out of current profits for three consecutive years. This is where Kishida’s promise of a new capitalism could have real meaning. He has the power to bid “sayonara” to Japan’s zombies for good.
Since the end of the bubble economy in the early 1990s, Japan has provided more-or-less free capital in a bid to shelter local companies from the forces of asset deflation, technology-induced disruption, rising capital costs and other forces of creative destruction. About 80 per cent of Japan’s zombies took on more debt under pandemic support schemes.
Such companies drag down industry, macroeconomic performance, productivity and financial returns. They have been sheltered for far too long by yen appreciation depressing the true costs of doing business.
What does this have to do with the yen? Well, if global investment in Japan starts to pick up, this is one potential source of demand for the currency. However, in the end, it will always be Japanese investors who hold the key to the yen’s fortunes. Japan is, after all, the world’s largest creditor nation.
For the last decades, Japanese investors have been underinvesting in their own markets. That will only change if and when domestic companies present credible business strategies. Clearly, domestic investors do not believe the current value proposition of Japan Inc. That’s why half of Japanese companies are trading below the book value of their assets. Investors think the assets are underutilised and not sweated enough.
The price signal from the currency is triggering more competition for Japan’s most precious resource — human capital. At today’s exchange rate, a brain drain has started. Nurses are increasingly reluctant to seek their fortunes in what has become a low-wage, low upside career destination. Engineers are leaving, either poached by global companies expanding their local presence or emigrating.
And the risk of an accelerating brain drain is where maximum pain starts for Japan. The weaker the yen, the more likely Japan’s top-talent will move. This, in turn will force corporate leaders to fundamentally rethink strategies. For example, the new chief executive of NTT — one of the most heavily unionised companies in Japan — is now introducing pay-for-performance compensation, a radical break with the seniority-based culture of the postwar era.
If yen depreciation spurs such changes, it will not just have done its job, but will actually reverse very quickly as Japanese investors see real potential in the home economy and corporate sector. If combined with foreign investment, this could be an incredible force for future prosperity. I know this is a big if, but let’s give optimism a chance. Either way, a wave of new inward investment has started.
