Could recent yen softness finally herald the time when Japanese policymakers run out of road?
The yen has dropped back 6% from its recent trade-weighted high set in early August.
Of course, that has to be set in context. The yen is still not far from historic trade-weighted highs reached in January and nearly touched again over the summer. It is still 75% above where it was in 1990 and 40% above its summer 2008 levels when the financial crisis started to buffet the markets.
So whatever the yen's recent weakness, its longer-term trend of strong appreciation mustn't be ignored.
And yet there are reasons to suspect that the latest pullback might herald more than just a temporary correction. The parliamentary election being held on Dec. 16 comes at a time of fresh economic weakness. Lombard Street Research figures Japan is probably in recession.
The opposition Liberal Democratic Party is promising an expansion of government spending and pressing the Bank of Japan to deliver 2% inflation and increase cooperation with the government. Some are reading this to suggest enforced debt monetization and a de facto elimination of BOJ independence.
That's a problem.
The Japanese government has been running ever more massive budget deficits since the bursting of the Japanese bubble in 1989 in an effort to keep the economy afloat. Since 1992, the government has run, on average, an annual deficit of 6.2% of GDP. Even so, it has only managed to produce an average annual growth rate of 0.8%.
Not a great return for an ultimate cost of increasing its gross national debt from 71% of GDP in 1992 to 237% this year. In any other country, such a huge increase would by now have triggered a Grecian-proportioned economic crisis.
Why hasn't it? Because Japanese households and funds have been willing purchasers of Japanese government debt. They own more than 90% of it. Cautious savers and high savings rates have covered the gap and, given Japan's low growth rate and deflationary trend, the Japanese government has managed to finance its deficits at exceedingly low nominal interest costs.
But things are changing. Demographics of an ageing population mean that the Japanese savings ratio has been falling and will, before long, go negative. Once the Japanese saver stops buying Japanese government bonds, the deficit has to be financed from somewhere. The suspicion is the Japanese government will force the Bank of Japan to do it through outright deficit monetization.
Anyone holding the yen has to be wary of this outcome. Of course, Japan wants a weaker yen to boost the competitiveness of its export industry. But the degree of weakness is something that policymakers ultimately might not be able to control.
Outright monetization of deficits the size Japan's been running is a short-cut to currency freefall. The fiscal and monetary parachutes being used to stabilize the Japanese economy will be worse than useless. They'll end up being a noose for Japanese savers, triggering huge inflation.
Maybe that's what Japan needs. The burden of working to support a vast elderly population seems to have crushed the younger generations of Japanese. This burden could be behind an unwillingness to have children and a consequent shrinkage of the population.
By wiping out older savers through inflation, the young would effectively transfer resources to themselves. This could then provide the stimulus to have bigger families and drive economic growth. Albeit with considerable upheaval along the way.
This is an opinion column by Alen Mattich, who has been a columnist for Dow Jones for more than a decade. Write to him at alen.mattich@dowjones.com or on Twitter @AlenMattich
