Thursday, 11 April 2013

Japan - Exporting Deflation?

It's been well publicised how the aggressive 'loose' monetary policy adopted by central banks is likely to be inflationary. The logic of this seems sound; they are printing trillions of dollars of money, and an increase in money supply should lead to inflation over the longer term.

Japan has recently undertaken extensive quantitative easing and has also directly attempted to depreciate their currency. One would presume this will cause inflation pressures; as mentioned above they have more money supply and also imports will become more expensive, thus importing inflation.

However, there is another take on this which I think is worth some consideration, and something I have not read too much about to date. Firstly we need to consider the Japanese economy. It is an export driven economy. Then we need to consider what a weaker Yen means for these exports. Well in essence it makes exports cheaper to foreigners who are importing them and this is the key to the deflationary pressures that Japan's latest policy could cause. So around the globe countries will be importing goods and services from Japan which are now cheaper, allowing businesses to lower prices and still maintain margins which could lead to deflation.

So what are the possible implications of this? Well the world has generally come to a consensus view that inflation could spike at some point due to the monetary stimulus mentioned above. However, if in fact Japan and other nations with weakening currencies are exporting deflation this may not be apparent, or at least to the extent markets are pricing in.

If you believe inflation may be 'overpriced' then one option is to 'short' inflation linked bonds whose returns are directly linked to inflation. Their price will fall if they have priced in too high inflation.

So for now lets hopefully look forward to some cheaper goods from Japan and be aware that high inflation is not yet a foregone conclusion!

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