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Historic Move by Bank of Japan Creates Selling Opportunity

What are the Risks?

Some analysts are skeptical, however, saying that the sluggish Japanese economy and weakness in export markets will prevent businesses and consumers from taking the added initiative to borrow more money. If this is the case, all of the extra cash will not flow out of the banks and into the real economy. In the worse case scenario, cheaper borrowing rates will incentivize the much-discussed "carry trade," as investors fund purchases in higher yielding assets using low yielders like the Japanese currency. Sending funds out of the country in this manner would greatly diminish the intended effects and do little to positively influence real economic growth.

This scenario does create the added positive of weakening the yen. A weaker currency creates benefits for Japanese export companies that are able to offer products at cheaper prices to overseas customers. These companies can then build on those profits once the foreign earnings are deposited back into domestic banks.

But even with these minor positives, we could see a long-term situation where policymakers become overly dependent on stimulus measures, and face an expanding money supply that is unmatched by real economic growth. Additionally, a surge in bond sales will lead to a massive increase in Japanese government debt, which is already the highest in the industrialized world (230% of GDP). Most economists agree that debt levels in this range are unsustainable.

If the BoJ's proposals are successful (and inflation does start to rise), interest rates in Japan will need to rise as well. A situation like this will create substantial increases in interest payments for the Japanese government (magnified by the size of the outstanding debt).

If the government does not have the cash to make those payments, more bonds will likely be sold to raise the necessary funds. If this sounds like a vicious circle, it should. At its April meeting, the BoJ did little to address these potential concerns, but it would be naive to assume that this means those concerns are not being felt.

What Does This Mean for Investors?

Now that the BoJ has laid a clear framework for its aims going forward, investment ideas should be based on the assumption that the Japanese yen is in the early stages of a long-term downtrend. If you are Japanese, this means you should spend all of your domestic currency. Or, at least, take your money out of Japanese banks and put it somewhere where you will not suffer a massive depreciation in purchasing power. If you are a non-Japanese investor, this means it is time to borrow in yen and use those funds to buy more productive assets in countries that are not as fiscally-stretched.
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