Wowzers! I didn’t realise until today that the Japanese Yen has lost more value than the Russian Ruble this month. The currency market a bit esoteric for you? Think again. I doubt it is a coincidence I have seen a marked pick up in pension queries in recent weeks too. Both developments are connected to the same wealth threat, inflation, but Japan itself could be the even bigger threat to your pension. So, without sounding like Fr Ted, I do think it important to look far far away to understand the second-order effect of inflation rates not experienced for over 40 years in developed economies. And, it’s big in Japan..

The Land of the Rising Sun and its population of 125 million is an economic and manufacturing powerhouse ranked 3rd in the world by GDP. However, this $5 trillion economy is particularly dependent on imports of raw materials and energy and that has attracted the attention of financial traders. Bluntly, traders smell blood as a Japan economy powered by its export sector would struggle if rapidly inflating input costs killed profitability, jobs, corporation taxes, banks etc. Here’s a taste of what’s been going on….

  • Yen/USD exchange rate moved through the 120 level for first time since 2016.
  • The Yen kept moving towards the 123 level with the biggest one day move seen in 20 years.
  • As the Yen lost value, so too did Japanese government bonds(JGBs).
  • The Bank of Japan(BOJ) had to intervene in the JGB market and announced it would buy “unlimited” amounts of the benchmark 10-year government bond.

Of course, bonds have been falling in value(and interest rates rising) all over the world since the beginning of the year but why are the BOJ so antsy? It’s all about debt; Mt Fuji quantums of debt. Japan’s government has been borrowing money for years to try to stimulate growth in the economy, and ironically generate some level of inflation. However, runaway inflation leads to rapidly rising interest rates(falling bond prices) and can cause real pain(rising payments) for those who are heavily in debt. Here’s the Japan debt story…

  • The government debt of Japan is estimated to be over $12 trillion.
  • That’s a debt/GDP ratio heading towards 250% . Yep, Japan is the most indebted country on the planet.
  • Now there is a mitigating factor in that the BOJ has purchased/owns almost 50% of the $12 trilllion government debt market(JGBs). Sound weird? You’d be correct. The Japanese government owes its own central bank an amount of money greater than the GDP of the country. And people think NFTs make no sense!
  • This is not the forum to debate the fiscal gymnastics involved in maintaining confidence in the Japanese currency and its government bond market. However, let’s just say the BOJ is extremely keen to avoid sudden bond and currency market moves.
  • This is a delicate BOJ balancing act which, arguably, has closed the JGB market. As an illustration, there are days when there is not single trade executed in the $12 trillion JGB market. Nada, zilch. Best not to think about that too much but imagine a commercial activity 4 times the size of the UK economy not even seeing a lollipop change hands.

Clearly, a Japanese financial market with too much volatility is not good news. It would signal the BOJ has lost control and then we are into ‘Japocalypse’ territory. I have used that cautionary descriptor numerous times over the years and thankfully Japan has coped with the 2008 credit crisis, the 2011 earthquake/tsunami and the Covid-19 pandemic. But, they all have been deflationary events rescued by global central banks pumping money into the economy. Now, we are in a situation where supply is the problem, not consumer or corporate demand. Inflation has not been seen for 40 years which means pension funds have been sticking to roughly the same investment strategies over that period. I’m conjuring up recent images of Russian tanks being destroyed by silent air-borne drones and wondering do pension strategies have the right equipment, or generals for that matter?

Japan is no butterfly in the context of the world economy but its financial ‘wings’ are probably not watched too closely by pension investors on this side of the world. Persistent inflation could quickly change that. The currency and bonds of Japan have been typically safe-haven investments so the following assets and activities will see unprecedented investor flight and disruption if Japocalypse emerges as a real risk.…

  • Global Debt Markets: Japan, despite its massive debt pile, is also the world’s second largest provider of external capital(creditor) globally after China.
  • Life Insurance: Japan is the second ranked life insurance market globally behind the US.
  • Property & Casualty Insurance: Ranked 4th in the world.
  • Currency Markets: The Yen is the third most traded currency in the world after the USD and euro.
  • Stock Markets: Total value of stocks traded in Tokyo stock exchange is almost $6 trillion and ranks 3rd globally.

The markets and instruments above will be dealing with inflation for the first time in 40 years. Some inflation is a good thing but not too much. So, it’s all about balance… except with your pension. Bonds really hate inflation as your quarterly pension update will confirm very soon.