Japan’s trade gap and the impact on the yen

Publication date: 5 January 2012
Author: Michael Derks, FxPro

Amidst the unrelenting focus on Europe’s slow-motion financial self-destruction last year, very little attention was paid to the deterioration in Japan’s trade fundamentals. In the first eleven months of 2011, Japan’s trade deficit exceeded JPY 2 trln (around USD 26 bn). Calendar 2011 will be the first year since 1963 that Japan has recorded a trade shortfall. Before getting too concerned, it is worth pointing out that last year’s earthquake and subsequent tsunami knocked out a significant proportion of Japanese production, capacity which is slowly being rebuilt. Exports fell 2.3% over the eleven months to November vis-a-vis the comparable period of 2010. As a result, imports increased to compensate for the inability of domestic production to satisfy local demand.

However, it is also the case that the ongoing strength of the currency has forced exporters to review their continuing presence in Japan – many of the country’s major car-makers, for example, continue to divert their production overseas. This relocation of production has been in evidence for a number of years, and will likely continue to weigh on Japan’s trade performance. There is no doubt that Japan’s trade advantage has diminished over recent years, both because of the currency and the increased competition from its Asian neighbours. Viewed in this context, it is little wonder that the MOF recently lifted the size of the currency intervention fund to an incredible JPY 195 trln (USD 2.5trln, or nearly one-half the size of the economy).

Although Japan’s amazing track record on trade is under serious threat, it is not clear that this represents imminent trouble for the currency. Japan continues to record a substantial current account surplus – in the first ten months of 2011, it totalled JPY 9 trln (USD 120bn). Notable is that the trend here has been worsening as well – back in 2007, the external surplus was JPY 25 trln.

Fortunately, Japan remains the world’s largest holder of external assets (on a net basis). In 2010, the net external assets position was a surplus of USD 3.25 trln. It is difficult to see the yen coming under sustained assault while it retains such a fabulous balance sheet position with the rest of the world.

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