Why Japanese markets have been creating turmoil for YOUR investments

Of the world’s seven richest economies, Japan is the most enigmatic. In an age when the West has degraded its manufacturing base, Japan is a powerhouse of steel making, shipbuilding and car making. There are few homes in Britain without either a Toyota parked nearby, a Sony entertainment device or computer without Japanese hardware.

The country is important to most of our lives as the ultimate owner of key assets such as brewer Fuller’s, computer systems provider Fujitsu, High Street fashion brand Uniqlo and the Financial Times newspaper.

Yet most Britons would be hard put to name the country’s prime minister, Fumio Kishida.

They would also have trouble identifying the nation’s stock market indexes, the Nikkei 225 and Topix, or recognise its financial significance to the world as a holder of $1.3 trillion (£1 trillion) of dollar assets.

In the past week, people in Britain and across the globe received a rare glimpse of how pivotal Japan’s £3.4 trillion-a-year economy, the fourth largest in the world, is to global finance.

The carry trade: The Bank of Japan’s shock interest rate move led to huge losses for domestic and global investors

When Japan’s central bank, the Bank of Japan (BoJ), raised interest rates against the advice of the International Monetary Fund and to the astonishment of traders across the globe, it ignited mayhem. There is already speculation that the BoJ may have more rises up its sleeve.

While stock markets (which have since recovered) plummeted across the world, the value of our pension funds and savings in shares tumbled. Alarm set in and asset managers and private investors rushed to reshape their portfolios.

I took a call from one close family member, who was shocked to see that his investments had dropped by many thousands of pounds while he was sleeping.

The market turmoil has put the spotlight on a country whose culture is a curiosity for most Westerners. Consumerism is eschewed in favour of saving, in spite of the nation hosting some of the world’s most elegant old-style department stores, such as Matsuzakaya.

Tokyo is a city that never sleeps, with discreet Michelin-starred restaurants and the rambunctious nightclubs of Roppongi. Yet it is the cleanest of cities where it would be possible to eat off meticulously maintained streets.

As for the stock market, before the recent turmoil it had endured 34 years of stagnation.

It was only in February this year that the Nikkei index managed to overtake a high point set way back in 1989. Finally, the nightmare of lost decades, which saw share and property values nosedive from peaks reached in the 1970s and 1980s looked to be over.

That recovery, which took so long to engineer, only became possible with Abenomics, a plan unveiled by late prime minister Shinzo Abe in 2012, seen by many as a tribute act to Thatcherism.

Faced with an ageing population, disinflation and low growth, Abe’s answer was to adopt an activist monetary policy, seek to bring a ballooning budget under control and put growth first.

Experiments with quantitative easing, buying Japanese government bonds, corporate bonds and other assets worked so well that America’s most revered investor Warren Buffett bought big stakes in five core finance and industrial houses Sumitomo, Mitsubishi, Mitsui, Itochu and Marubeni.

He increased his holdings in January this year. Where Buffett trod, other asset managers followed.

What dramatically changed matters was Russia’s war on Ukraine. The US’s recovery from the ;sharp rise in inflation and high interest rates left the other G7 countries for dust and the dollar soared against the yen.

This combination of a weak yen and low Japanese borrowing costs opened a tempting trading opportunity for hedge funds, arbitrageurs and asset managers across the globe. The Japan ‘carry trade’ was born. Some $500 billion or more was borrowed in yen and invested in high performing assets in other markets across the world. What could possibly go wrong?

The mercury suddenly changed. On July 31 the BoJ changed course by increasing its key interest rate to 0.25 per cent from the previous range of 0 to 0.1 per cent.

As significantly, it outlined a plan to unwind its huge bond-buying scheme after more than a decade of stimulus measures. The age of a cheap yen and super low interest rates was coming to an end. The currency fell more than 2 per cent to 150 yen to the dollar for the first time since March this year.

The final straw for the yen carry trade came on Friday, August 2, when the US government reported that America’s job creation miracle had stalled in July. The data raised fears that the US central bank, the Federal Reserve, had overdone its battle against inflation and that a recession loomed. The table was set for a mighty implosion when Asian markets reopened at the start of last week.

The change in sentiment was venomous as investors dumped Nikkei shares and the carry trade set in. Japan’s share markets suffered their worst slump since the 1987 crash, plunging an astonishing 12 per cent. The tectonic plates of capitalism shook as investors around the world dumped shares and bonds. The crisis was short lived and by mid-week a buying frenzy has sent the Nikkei back to where it had begun and more.

In the real economy of growth and jobs little had changed. The cars were still coming off Toyota’s production lines in record numbers. Buffett was selling Apple not Sumitomo shares.

The events of last week will have convinced critics that stock markets are no more than vast casinos. Maybe, but they can force real change. There is now a recognition that US interest rates have been too high for too long creating all kinds of distortions.

Fed watchers such as Nobel prize-winner and New York Times commentator Paul Krugman argue that the US central bank must now respond to the warning signal from Tokyo by cutting rates to head off an American and global slowdown at the pass.

When governments and central banks act rashly markets provide a harsh discipline. The seismic shifts on the Tokyo stock exchange may have stabilised. But it is inevitable that some professional and private investors will have been crushed in the rush for the exit.

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