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Japanese Election: The Promise of "Unlimited Easing" Sparks More Yen Weakness

Japanese equities have soared and the Japanese yen has weakened over the past week following prime minister Yoshihiko Noda's decision to dissolve the Diet and to call a Lower House election for December 16.

The Nikkei 225 Index, which is weighted more towards Japan's traditional export sector, is up 5.5% since the election was announced. The broad TOPIX index is up 6.2% The yen has fallen by 3.9%, more than 300 pips, and is now trading at an 82 handle for the first time since April.

The main reason for the weakness of the Japanese yen has been the repeated calls for "unlimited easing" by Liberal Democratic Party (LDP) president Shinzo Abe.

The LDP, which governed Japan from 1955 to 2009, is widely expected to be returned to power in the upcoming election. If the LDP wins an outright majority or leads a coalition government, Abe will become prime minister.

In the first few days of the election campaign, Abe made the case for aggressive monetary easing by the Bank of Japan to break the cycle of yen strength and deflation that is pushing the Japanese economy back into recession. Specifically, Abe wants the central bank to conduct "unlimited easing," with the aim of achieving 2% inflation and 3% GDP growth.

Among Abe's most controversial statements was his call for the Bank of Japan to directly finance a new wave of public works spending by directly purchasing construction bonds-off balance sheet government bonds used to fund long-term infrastructure projects considered to be investments.

Construction bonds are obligations of the Japanese government but are not considered to be part of the government's deficit.

"To protect people's lives and keep our children safe, we must implement public works spending and do so proudly," Abe said in a speech reported by The Wall Street Journal. "If possible, I'd like to see the Bank of Japan purchase all of the construction bonds that we need to issue to cover the cost. That would also forcefully circulate money in the market. That would be positive for the economy, too."

Abe has also stated that he would like to revise the Bank of Japan Law to make the central bank more of a tool of the government to be used to support government policies.

This has raised serious questions over the Bank of Japan's institutional independence.

Abe's comments, particularly the suggestion that the Bank of Japan directly underwrite construction bonds, have attracted much criticism, especially from BoJ governor Masaaki Shirakawa. "I want respect for the BOJ's independence as it's doing its utmost to conduct appropriate monetary policy," Shirakawa said, according to Bloomberg.

The Japanese Election Manifesto

On Wednesday, the LDP announced its official election platform or "manifesto" as it is called in Japan.

The key components of the economic platform are, according to government broadcaster NHK, "…placing a priority on breaking the cycle of yen strength and deflation, setting an inflation target of 2%, putting a revision of the Bank of Japan Law to strengthen the coordination between the central bank and the government within the scope of consideration, conducting unlimited monetary easing and, in order to enhance the competitiveness of Japanese industry, cut the corporate tax rate and promote investment in advanced industries."

It is also important to note the Abe is opposed to joining the Trans-Pacific Partnership (TPP), being promoted by President Obama during his trip to Southeast Asia "if there will be no exceptions to eliminating all tariffs." Abe's rival, Democratic Party of Japan (DPJ) prime minister Noda, has made joining the TPP the cornerstone of his campaign.
At a press conference following the announcement of the LDP election platform, Abe walked back some of his more strident remarks. According to Asahi Shinbun, a major daily newspaper, Abe's original wording regarding the Bank of Japan Law was "including the revision of the Bank of Japan Law." This was changed to the more moderate "putting a revision of the Bank of Japan Law within the scope of consideration."

Asahi also reported that Abe "clarified" his position on Bank of Japan purchases of construction bonds. "I never said that the Bank of Japan should buy construction bonds directly," Abe said."They should buy them in the market."

Abe's walk back comments have not yet been reported in the English language press. For the time being, the markets seem to be happy buying Japanese equities and selling yen on the assumption that Abe will head the next government.

But, this election, Japanese politics are even murkier than usual. Nearly half of all Japanese voters are still undecided and support for the two major parties is waning. A number of viable third parties have emerged which makes it unlikely that either major party will win an outright majority. These third parties could be the deciding factor in who gets to run Japan under a coalition government.

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