Next Stop ¥120: Pol Eco of Weak Japanese Yen

Albert Edwards of SocGen, ever on the lookout for trouble in the world economy, is pointing us in the direction of a weakening yen. What's so bad about improving the competitiveness of Japan, a country that's been mired in a quarter of a decade-long slump? As with other international political economy matters, you need to understand the effects of Japan's devaluation alongside other countries in the region and, indeed, the rest of the world. Being Albert Edwards, he's foreseeing (surprise!) dire consequences for the world economy:

1. China’s economy will see a further rise in its already strong real exchange rate, especially if other Asian currencies get pulled down with the sliding yen. That will hurt China’s economy, which, judging by data from August, shows it’s on the wane again. And a strengthening renminbi will also worsen deflationary pressures.
2. A weak yen spells trouble for the west as a wave of deflation will wash in from the rapidly devaluing east, reversing a decade-long trend. Given that profits growth is so anemic in the west, monetary tightening via strengthening exchange rates could be enough to “send U.S. and European profits into outright decline and subsequently their economies into recession.” (Edwards isn’t the first analyst to warn about what a stronger dollar will do to corporate earnings).

China is stuck between a rock and a hard place. It is no longer the lowest-cost production site as the likes of Bangladesh and even Laos muscle in on that front. On the other hand, it cannot begin devaluing the renminbi anew to maintain competitive parity with Japan lest it draw further ire from protectionist Americans and Europeans who are quick to criticize "competitive devaluation" and hit China with all sorts of retaliatory measures.

Edwards' forecasts for Europe are more intriguing, actually. Devaluation emanating from the Asia-Pacific will further hurt measures in the West to escape its grasp. What's more, a stronger greenback will negatively impact earnings when reported in dollar terms. Add weak profit growth in home (read: developed) markets to strong exchange rates and it adds up to potential trouble.

Interesting stuff. In particular, the chart above which shows how then yen breaking the 15-year trendline opens up a decline to the longer-term 25-30 year trendline is worrisome as it might be the trigger for an Edwards-esque scenario. Next stop 120 yen to the dollar? You'd be naive to rule it out.