Japan – Is a Cost of Living Crisis Looming?

Inflation, inflation, inflation. If you have been reading the financial news, or even just the regular news, you will have heard a lot about the rise in the cost of goods and services this year. From the US to Europe, politicians have been desperately trying to shift the blame for the crisis away from their own central banks unprecedented money printing to the President of Russia. Whether they get away with such misdirection is yet to be seen, but President Putin himself is having none of it, as you can tell from this excerpt from one of his speeches.

Putin, while clearly not deserving of support, is absolutely right that Europe and the US have created this mess for themselves, and there is no doubt that he is now exploiting this weakness by regulating the flow of gas into Europe, making for a very uncomfortable winter ahead for Germany in particular, and the rest of Europe and the UK also. I didn’t realise until I read this BBC article that “A younger Vladimir Putin did his PhD thesis on the importance of Russian energy exports.” The Germans should have seen this coming a long way out. Having pumped up the money supply, and also made themselves dependent on cheap Russian energy, the EU and UK leadership have some gall to refer to the current situation as a “cost of living” crisis…

However, the goal of this post is not to discuss geopolitics. As a resident of Japan, I am interested in knowing if the inflation monster is lurking in Tokyo Bay, ready to go Godzilla on the Japanese consumer? As fellow Japan residents are well aware, Japan has not seen inflation in decades, and, as noted in Japan Mortgages – Fixed or Floating?, Bank of Japan boss Kuroda-san threw everything but the kitchen sink at the problem in order to reach the magic 2% mark. Now, with inflation at 2.5%, the yen at 25 year lows against the dollar, and the rest of the world facing a food and energy crisis, you can’t help wondering if prices aren’t going much much higher.

Of course, when it comes to the big questions of economics, the only correct answer is that no one knows. In general, financial journalists and macro gurus have a bleak outlook for Japan. With the US Federal Reserve still intent on raising rates to fight inflation there, the yen looks anything but safe at the 140 level, and a weaker yen could mean higher imported inflation. Another spike in energy prices due to the Russia / Ukraine situation and things could get expensive quickly.

Interestingly though, there is an optimist in our midst. Jesper Koll, according to his profile, is an economist, strategist, angel investor, patron, producer, and yes, a Japan optimist. Resident of Japan since 1986, and with experience at two major US investment banks, he has a new substack titled, of course, Japan Optimist. And it was there I found his July post titled: Who’s afraid of inflation? Not Japan

I encourage you to read the post yourself, but here’s a short summary:

There are two reasons that Japan is less impacted by inflation than other developed countries, for example the United States:

  1. The government here is not afraid to intervene in markets to preserve the purchasing power of the people. About one quarter of goods and services are subject to government regulation, which effectively means price controls. This goes for health care, education, transport, and staple foods. This year surging gasoline prices have been kept under control by government intervention
  2. At the same time, Japan’s domestic industrial structure is much more cut-throat competitive. In the US, the big players control twice as large a share of the manufacturing and service industries. Japan is more fragmented and competitive, and that competition keeps prices low.

Jesper notes that the Japanese government not only considers it important to protect citizens from economic shocks, but it also has the necessary parliamentary majority to act far more quickly than the US government is able to. So unlike in the US, where the Federal Reserve is having to fight inflation on its own, the Bank of Japan gets plenty of backing from the government.

Japan’s government and economic system comes in for so much bashing in the media that it’s almost shocking to hear from someone as positive as Jesper. And once more I’ll remind you that no one really knows how the global inflation issue will play out, here or abroad. However the lack of polarization over every issue certainly puts Japan in a better position to take action than much of the western world.

From a financial planning perspective, inflation is something you should always be concerned about. I would argue that the whole point of investing is to at least keep pace with, and preferably outperform, the rise in the cost of goods and services over time. To put it another way, it’s all about preserving and increasing spending power. Remember, it’s not the cost of things that is going up, it’s the value of money that is going down. At the risk of sounding like a broken record, beating inflation in your base currency is the name of the game. Whether inflation in Japan gets worse or not, if you are going to spend the money in Australia, saving and investing in JPY does not really help you.

If you are planning to stay in Japan long term and JPY is your base currency, here are a few things you can do to protect yourself against inflation:

  1. Keep an emergency cash reserve – make sure you have a buffer in case prices increase more than expected.
  2. Invest – anything surplus to your cash reserve can be invested for the medium to long term, whether it’s NISA, iDeCo, a brokerage account, ETFs, dividend stocks, REITS, gold. You are not going to preserve your spending power sitting in JPY cash.
  3. Expect volatility – you need to be mentally prepared that your investments are unlikely to just go up in a straight line in this environment. Remember you are trying to beat inflation over time, not in the next 6 months.

Finally, if you enjoyed a bit of optimism for a change I recommend checking out Human Progress. Their Twitter account is here. With all the doom-scrolling it’s sometimes nice to be reminded how much progress we have made as a species!

Disclaimer: This should go without saying, but the information contained in this blog is not investment advice, or an incentive to invest, and should not be considered as such. This is for information only.

The Yen and the Dollar Milkshake Theory

Back in April I wrote about the weakness in the Japanese Yen and how it can affect life and the economy here. Since then, I’ve noticed that in relation to the Pound and the Euro, the yen really hasn’t moved quite so much. In fact, both of those currencies have also dropped significantly against one other currency: the mighty US Dollar.

This reminded me of a term that keeps cropping up in my reading, and led me to take a closer look at the Dollar Milkshake Theory. Developed by Brent Johnson, AKA Santiago Capital, the theory envisages a scenario that appears to be playing out before our very eyes, whereby rapid USD appreciation sucks liquidity into the US and destabilizes world markets

This 6 minute Video provides a brilliantly simple explainer on what the Dollar Milkshake is and how it could play out.

A huge “milkshake” of liquidity has been created by global central banks, who have injected some $20 trillion in various currencies into the global economy since 2008. And everyone needs dollars. Whether it is to trade in commodities, shore up currency reserves, or to pay interest on USD debt: China needs dollars, Europe needs dollars, and Japan needs dollars. Despite significant money printing in America in the last decade there is still a shortage of dollars. Other countries have also been printing their own currencies in similar amounts. The demand for dollars is, quite simply, outstripping the supply.

More important even than the availability of dollars, is the rate of change in the level of the dollar. If that level rises too fast, then problems start popping up all over the world. That’s when countries like Sri Lanka and El Salvador start showing up in the news. When things get bad and the dollar rises rapidly, the rest of the world needs to print more and more of its own currency to convert to dollars to pay for goods and service its dollar debt. This means the dollar keeps on rising, forcing other countries to devalue their own currencies, which in turn makes the dollar rise further. And because in this environment the US looks like a safe haven, capital is sucked into the country which again pushes the dollar higher. Sooner or later we end up with a full on sovereign bond and currency crisis, which is bad news for the whole world, the US included.

Long periods of dollar strength have often ended with major financial dislocations, like the Asian crisis of 1997, so if the dollar continues to rise we could see some extreme volatility in markets.

So what does this mean for the Yen? Well, having just broken through a 40 year support line, things are looking pretty treacherous for JPY. We are probably near a point where, if the yen continues to fall against the dollar, we may see the first Japanese intervention in the currency markets in over a decade. You have to go back even further to find the last time Japan sold USD/JPY in order to support a weak yen, and guess what? It was in 1998 during the Asian Financial Crisis, when the USD/JPY was trading at 145. Note, we’re at 138 today…

As the title suggests, the Dollar Milkshake is just a theory. There is no guarantee that things actually play out this way, but there is a reasonable probability that we will witness what Raoul Pal calls a “dollar wrecking ball” scenario either now, or in the next few years. So how do you invest in an environment like this?

First and foremost, as I stressed in the Weak Yen Dilemma, know your base currency. Being in the wrong currency can sometimes hurt you more than a fall in investment value. On the other hand, if you hold dollars, but you are planning to spend the money in yen, you are looking at a golden opportunity to bring some money into Japan.

Secondly, remain diversified. With inflation still on the rise, this is not a good time to be sitting in cash, but it’s not a time for excessive risk either. If things get crazy that little bit of gold and silver (and maybe even Bitcoin) in your portfolio could come in handy.

If you want to be a little tactical, one area to avoid is emerging market debt. These are the countries that often issue dollar denominated debt, and are going to struggle to meet interest payments in a rising dollar environment. So maybe stay away from emerging market debt ETFs / funds for the time being.

Lastly, I think it’s key to stay patient. Extremes in markets do not last forever and reversion to the mean occurs eventually, milkshake or no milkshake.

Disclaimer: This should go without saying, but the information contained in this blog is not investment advice, or an incentive to invest, and should not be considered as such. This is for information only.

The Weak Yen Dilemma

If you watch Japanese news you will have noticed a new topic that is featured in almost every broadcast. Along with Ukraine and Covid, no news program is complete without discussion of 円安 or the weak yen. JPY has indeed taken a battering this last few weeks, slipping from the 112 range vs. USD to as low as 129. I also noticed a lot of discussion on Twitter as to the reasons for the drop and what to do about it, so let’s take a look.

Why has this happened? There is no limit to how deep you can go into exploring the reason for the yen’s fall, but the simple explanation is always best: Currently the US is raising interest rates, and Japan is not. That makes the USD a more attractive currency than JPY. It’s simply supply and demand at work.

What are the effects of a weak yen? The Japanese government and the Bank of Japan have been perfectly happy with a weaker yen for some time. It’s a big boost to Japanese exporters as it makes Japanese products cheaper overseas. However, you can have too much of a good thing. The current yen level is certainly doing more damage than good to the Japanese economy as businesses are hit with the double whammy of rising energy prices and a weaker currency. For the Japanese consumer, who is already facing rising prices, it means the cost of imported goods are going to rise even further. In a country with stagnant wages that means less money in the pockets of the populace, who in turn are cutting back on the little luxuries. This leads to a vicious circle where businesses must keep the cost of their products low, because low wages mean people won’t buy them otherwise, so those businesses make less profit and are therefore unable to raise wages… It’s not a pretty picture.

For the foreign resident in Japan a weak yen can bring either joy or pain, depending on your situation. Paid in dollars? Life is good! Paid in yen with expenses / debt overseas? Times are hard. Trips back home are certainly going to be more expensive. There are probably things you wish you had thought about earlier, which is why this financial planning thing is kind of important.

How long will this last? The simple answer to this is nobody knows. The last time the yen was anywhere near these levels was 2015. However in 2012 it was 76 yen to the dollar. So it’s unlikely it will go on forever – things move in cycles. That said, we are in a precarious place at the moment. Usually if the US is raising interest rates it is to keep pace with inflation. However inflation in the US is already almost 8% and the federal funds rate is only 0.25%. The Fed is well behind the curve, but is sharply aware that raising rates too rapidly will crash the economy. So expect the US interest rate to keep rising through this year, which means more pain for Japan. Also, as noted in this thread by Santiago Capital, what is happening now is the Bank of Japan is sacrificing its currency to save its bond market. Other nations should take note as they may end up doing the same thing further down the line…

What could reverse it? Firstly, what won’t reverse the current position is Japan raising rates, because that is not going to happen. That would sink the whole ship. The thing most likely to bring things back into balance is inflation starting to ease in the second half of the year, meaning the Fed is under less pressure to raise rates. So if you are looking for a ray of hope, keep an eye on that.

What can I do? Here is the crux of the matter. Obviously what you should do depends on your own situation, but now is as good a time as ever to make sure you understand what your base currency is. Your base currency is the currency you are planning to spend your savings in. If your BC is JPY, you don’t really have a big issue. Real inflation in Japan is probably running at around 2% so you should look at investing in some dividend paying Japanese stocks to beat that. (see my previous post) If you have money overseas that you would like to bring to Japan, now is a great time to do it!

If your BC is something other than JPY and your money is in yen, you have a dilemma: It’s not a good time to exchange your JPY for your base currency right now, but if you don’t you are losing purchasing power in your BC to inflation. I’ll use the US as an example: inflation in the US is 8% – if you have money in the bank in Japan you are losing 8% per year to inflation. If you switch that money to USD cash you are still losing 7.75%! So ideally you want to have that money invested in USD in something that will, on the average, generate an 8% p.a. return, which pretty much means US stocks. So you have to weigh the trade off – is it worth taking the currency hit to get into the correct currency and get the money invested? If that was me, I have to say I would be inclined to wait for now and see how things develop in the coming months, but I wouldn’t want to do nothing for too long.

If you have debt overseas, such as a student loan, which you are paying interest on, I would probably say you should bite the bullet and keep paying it, despite the poor exchange rate. That debt isn’t going to get any smaller if you leave it.

Finally, if you understand, or are learning Japanese I came across this video by Nakata Atsuhiko, which is both a wonderfully simple explanation of the current weak yen situation, and an excellent Japanese comprehension exercise where you will likely learn some new financial terms.

Hang in there everyone!

Disclaimer: This should go without saying, but the information contained in this blog is not investment advice, or an incentive to invest, and should not be considered as such. This is for information only.

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