Yen at 120 Seen Needed by UBS Wary of Weimar-Japan Redux

Japan's Economy
Pedestrians walk past a department store in the Ginza district of Tokyo. In a sign that a sales-tax increase in April is weighing on Japan’s economy, government data today showed that industrial production rose less than expected in July, climbing 0.2 percent from June. Photographer: Tomohiro Ohsumi/Bloomberg

The new chief investment officer for Japan at UBS AG’s wealth management division likens the nation to a man with $1.2 million in debt who is spending all his $53,000 salary and still borrowing $40,000 a year.

Japan has no option but to fuel inflation to reduce its borrowings, while the challenge is to avoid the hyperinflation that engulfed Germany’s pre-World War II Weimar Republic and impoverished its people, according to Fumio Nakakubo, who joined UBS from BlackRock Inc. this year. The yen must drop to about 120 per dollar to spark the increases in consumer prices needed to reduce Japan’s debt load, he said.

“No matter how much we pump up the economy, that alone probably won’t be enough, so we have to weaken the yen,” said Nakakubo, 49, by phone on Aug. 27. “There is no other way.”

UBS expects the yen to depreciate to about 105 per dollar in 12 months’ time, as the currency dropped to the lowest since January this week after Federal Reserve Chair Janet Yellen said the U.S. may raise interest rates sooner than anticipated, while Bank of Japan Governor Haruhiko Kuroda signaled more stimulus is possible. Japan’s government estimates its debt, including regional arrears, will exceed 1,200 trillion yen ($11.6 trillion) this year, more than the combined gross domestic product of Germany, France, Italy and the U.K.

Expectations for more stimulus helped cut the yield on Japan’s benchmark 10-year yield to 0.485 percent yesterday, the lowest since April 2013, as the BOJ buys about 7 trillion yen of sovereign notes a month. The rate was 0.49 percent today, while similar-maturity U.S. Treasuries yielded 2.33 percent.

Avoiding Default

The high level of assets held by the Japanese government and bonds owned by domestic investors, as well as avenues for raising taxes in a crisis, will likely enable Japan to avoid default, according to UBS’s Nakakubo. Still, there is little historical example of a country expanding its monetary base to the level Japan has done and successfully keeping a lid on inflation, he said.

Germany experienced hyperinflation in the 1920s, when the government printed money to finance World War I reparations. Confidence in the Weimar Republic, Germany’s first full-fledged democratic system, was undermined. By the end of 1923, prices were doubling every 49 hours, and one U.S. dollar was worth more than a trillion German marks, prompting people to bring their money to shops in a wheelbarrow.

“Inflation is like drugs,” Nakakubo said. “Even if you know it will kill you, you can’t stop.”

JGB Holdings

Domestic ownership of JGBs has increased to 91.6 percent at the end of March from 91.4 percent in December 2012, when Abe took office, according to BOJ data. The nation’s households held financial assets of 1,630 trillion yen as of March 31, according to the BOJ data, while government assets totaled about 640 trillion yen at the end of March 2013, according to government statistics.

“Everybody is totally relaxed with long-term interest rates really low at 0.5 percent, but if rates rise, interest payments will surge,” Nakakubo said.

Abe’s administration forecasts that, even at current interest rates, it will have to spend 23.3 trillion yen this year to finance debt, the equivalent of 47 percent of forecast tax revenues, according to the Ministry of Finance. The figure is larger than expenditures planned for defense, education and other outlays.

First Arrow

Kuroda, hand-picked by Abe, unveiled a plan in April 2013 to double the nation’s monetary base to 270 trillion yen in order to fuel 2 percent inflation. Monetary easing is the first of Abe’s so-called three arrows, with the other two referring to fiscal stimulus and structural reforms.

Japan can avoid default under Abe in part through raising funds such as through a stake sale in Japan Post Holdings Co., according to Martin Malone, a global macro policy strategist at Mint Partners Ltd.

The Japanese government plans to sell a stake in the postal holding company, which had net assets of 13.4 trillion yen as of March, as early as next year. The Ministry of Finance plans to close an application period for investment banks and brokerages to propose on the deal today.

“The issue is whether the BOJ wins or loses in its economic assessment,” according to Malone. “Since Kuroda took over the BOJ’s bullish economic assessment has proven to be correct, while the private sector was wrong.”

Yen Weakening

Malone said he expects the yen to fall to 110 against the dollar “in the not too distant future.” The Japanese currency has risen 1.4 percent this year to 103.80 per greenback as of 3:22 p.m. in Tokyo, after sinking 18 percent in 2013.

Kuroda told central bankers in the U.S. last week that his policies were having their “intended effect.” The BOJ would adjust policies if there were any large risk to prices, he said earlier this month in Tokyo, adding that he didn’t see any reason for the yen to strengthen.

In a sign that a sales-tax increase in April is weighing on Japan’s economy, government data today showed that industrial production rose less than expected in July, climbing 0.2 percent from June. Household spending decreased 5.9 percent from a year earlier, while inflation excluding fresh food remained unchanged from June at 3.3 percent. Stripped of the effect of the higher sales levy, core consumer prices rose 1.3 percent in July, according to the BOJ’s estimates.

Japan’s central bank may just be pushing into the future a crisis caused by the nation’s unsustainable debt, according to Takeshi Fujimaki, a former adviser to billionaire investor George Soros.

“The first arrow helped prevent a financial collapse, this year and last,” Fujimaki, who now holds a seat in Japan’s upper house of parliament, said in a seminar in Tokyo on Aug. 25. “The problem is it has just made the boil larger and the collapse will be only bigger.”

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