Japanese Economic Recovery Could Be Catalyst For Run On The Dollar
Paul Kasriel
Overnight it was reported that Japanese real GDP growth in the first quarter was revised up to 6.1% annualized growth from the first-reported 5.6% growth. In the past two quarters, Japanese real GDP has grown at an annualized pace of 6.73% -- the fastest two-quarter growth since 1990 (see Chart 1). Year-over-year, Japanese real GDP is up 5.65% in the first quarter - the largest percentage increase since the first quarter of 1991. Now, it is doubtful that Japanese real GDP growth will continue at its recent rapid rate, but what is not doubtful is that the Japanese economy has finally come out of its decade-long hibernation. What also is not doubtful is that Japanese deflation is waning.

Chart 1

The Bank of Japan (BOJ) has become one of the principal sponsors of the U.S. dollar. In an attempt to restart the Japanese economic engines and to "fight" deflation, the BOJ has sought to restrain the yen from doing what might come naturally - appreciate vs. the greenback. The BOJ does this by purchasing dollars in the forex market, paying for them with freshly-printed yen. This, in combination with the improving health of Japanese banks, appears to have resulted in an acceleration in the Japanese money supply. As shown in Chart 2, the Japanese monetary aggregate, M2 + CDs, has grown at an annualized rate of 3.3% in the first five months of this year - the fastest five-month growth since early 2002. With both the Japanese economy and banking system improving, chances are Japanese money supply growth will grow even faster in the future.

Chart 2

What all of this implies is that come early 2005, the BOJ may see a benefit to a stronger yen and may start to back away from its zero-interest-rate policy. If private global investors do not fall in love with the dollar again, then the dollar could take quite a tumble as the BOJ withdraws its support. A sharp depreciation in the dollar would lead to a spike in U.S. inflation and a spike, rather than a measured increase, in U.S. interest rates. Somehow, I do not believe the U.S. housing market would thrive under these conditions.


June 12, 2004

Paul L. Kasriel, Director of Economic Research (plk1@ntrs.com)

The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.