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1.) Deflation

One major problem that’s been giving Japan a migraine for the longest time is the seemingly unsolvable problem of deflation. This very sticky situation, which is characterized by a steady decrease in price levels, could lead to a prolonged period of loose credit conditions and asset price bubbles. Yikes!

Just last month, Japan reported a 1.3% year-over-year decline in core CPI, which could print another drop of 1.2% this March. Last week, Japan printed worse than expected results for its corporate services price index, which is considered a leading indicator for inflation – or in Japan’s case, deflation. In fact, Japan has been sliding down a deflationary spiral even before the onset of the global financial crisis. And did I mention that the BOJ expects prices to drop for five more years?!?

2.) Strengthening Yen

After trading above the 100.00 price handle a year ago, the USDJPY has dropped to as low as 85.00, which translates to about a 15% fall! Why does this concern the BOJ? As I’ve pointed out time and again, the Japanese economy is heavily export based. As the yen appreciates, Japan’s exports become more expensive which in turn puts downward pressure on demand.

It only makes sense that the BOJ would want the yen to depreciate to help Japan’s export industry out. What I find funny is that this is a well known fact, and that the BOJ has been known to intervene in the markets in the past. Yet we don’t hear a peep out of the US calling out Japan as currency manipulators, like they have done so far with China! Ha!

3.) Falling Wages and High Unemployment

Another hitch that has been giving Japan more head and heart aches is the drop in employee wages. Latest data show that general wages in Japan slid by 6.1% in December, its fastest monthly downturn. Monthly wages which include overtime pay were cut to ¥549,259 as bonuses were pared by about 15%. This cut in employee salary is likely to put a lot of pressure on consumer spending. I mean, how can you expect them to buy that brand new Wii game with a much smaller paycheck?

While Japan’s jobless rate has improved to 4.9% from 5.2%, adding 130,000 jobs in December, it remains relatively weak. Looking at the historical numbers for the last five years, with the exception of 2009, the last time Japan’s jobless rate reached a high of 4.9% was back in August 2004. Despite its downtick, a declining jobless rate won’t be enough to buoy the economy if wages are sliding on the other side.

4.) Record High Deficit

Just yesterday, the Japanese government pushed for a record ¥92.3 trillion budget for the next fiscal year, which gives me more reason to believe that economic growth in the country remains very weak. This huge budget will be used to fund further stimulus measures like providing additional income for farmers and actually just handing out “free money” to households with young children. With the current USD/JPY spot rate, that roughly equates to a whopping $1 trillion! Just in case you’re wondering, this is how a trillion dollars looks like!

PoD Chart

Is the USDJPY’s downtrend finally broken? Are fundamentals finally catching up? Shall we bid sayonara to the yen’s strength and welcome the coming of a brand new quarter? I don’t know but it’s going to take more than a pill or two to cure Japan’s headaches!