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The news of the Japanese recession has taken economists by surprise, but the problems with the Japanese economy have been so entrenched that no negative news should come as a shock.
You see, Japan has been battling with deflation for most of the last two decades.
Deflation is a particularly nasty economic phenomenon because falling prices means consumers are sitting on the sidelines, waiting for prices to fall more. This reinforces falling profits, flagging demand, and keeps a lid on the economy from achieving substantial growth.
To combat this, Japanese Prime Minister Shinzo Abe has embraced a plan called "Abenomics."
Abenomics is comprised of three elements, known as "arrows." The first arrow would conduct monetary policy through an annual 70-trillion-yen-a-year bond purchase known as "qualitative and quantitative easing," or QQE. The second arrow, addressing fiscal policy, was to deliver stimulus. And the third was to address structural reform.
Japan announced in October that it would up QQE to the tune of 10 trillion yen, to help spark inflation and reverse the current deflationary trend.
And that's the overarching theme here.
Japan wants inflation. It wants its currency to be devalued to both prop up export-driven demand, and get consumers off the sidelines who are anticipating a drop in prices.
But Abenomics hasn't had the success it had hoped for.
Yes, the yen has been falling in value against the U.S. dollar. But the inflation rate has struggled to make any meaningful and consistent moves up.
You see, most of the yen's falling value is coming from traders and speculators. Speculators have been shorting the yen in high numbers since Abe first embarked on his quest to devalue the currency.
And the actions of speculators betting on the currency's downfall are creating this self-fulfilling prophecy.
Inflation can be characterized by the old adage of "too many dollars chasing too few goods."
The reason why inflation is stalling out is because the dollars aren't "chasing." And unless Japan can find some way to spur private demand, which has fallen in three straight quarters, it can print all the yen it wants and the inflation figures still won't budge.
And what's worse is that Japan is grappling with the largest debt-to-GDP ratio in the world, at almost 250%.
Deflation only makes this worse, by adding to the real value of debt.
And in trying to address the budget deficit, Japan is operating on two conflicting planes.
On one end, Japan is printing hundreds of trillions of yen and flooding the economy to stave off deflation.
On the other end, Japan has already hiked the sales tax once, and is slated to do it again, to build revenue.
The last tax hike helped Japan by stirring up demand in one quarter only to have it plunge in the next quarter.
In the first quarter of 2013, the annualized GDP growth rate was at 5.1%. But then it spiraled downward when the tax went into effect, shrinking by 0.1% in the fourth quarter. This was because consumers ramped up purchasing in the prior quarter to avoid the added sales tax hike in the quarter to follow.
The Japanese economy right now is a sad story, but that doesn't mean the profits aren't there for an investor looking for a play on Japan.
How to Play a Falling Yen
The USD/JPY is now at almost 117. This is up from 112.33, or 4%, since the Bank of Japan made its announcement that it would expand QQE.
There are a couple of ways to play the falling yen.
You can go straight for the short, or you can buy shares in the ProShares UltraShort Yen ETF (NYSE Arca: YCS), an exchange-traded fund whose share price rises whenever the yen falls against the U.S. dollar.
Money Morning Chief Investment Keith Fitz-Gerald, who recommended the YCS in February 2012, said he can see the USD/JPY currency pair growing to 200 in the next two years.
This means there's still about 70% gains to be made, even if you didn't jump on the initial trade.
On FOX Business' "Varney & Co." today (Monday), Fitz-Gerald also said you can buy Chinese telecom makers because they "are going to be buying lots of Japanese electronics now that they're being put on sale because [Japan's] currency is going down."
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