On Kuroda and Iwata at the BOJ Monday, February 25, 2013 Donald Luskin

Trend Macrolytics, LLC Donald Luskin, Chief Investment Officer Thomas Demas, Managing Director Lorcan Roche Kelly, Chief Europe Strategist

TRENDMACRO LIVE! On Kuroda and Iwata at the BOJ Monday, February 25, 2013 Donald Luskin

Abe picks doves and interventionists -- despite G-20 pressure, he has followed through.

Haruhiko Kuroda is reportedly to be nominated as governor of the Bank of Update to Japan by new Prime Minister Shinzō Abe. Kikuo Iwata is reportedly to be strategic view nominated as deputy governor. Both men are interventionists and doves, and selecting them is a courageous move by Abe, fulfilling his promise to BOJ, ASIA STOCKS, ASIA MACRO, FX: reform the Bank of Japan's policy apparatus with the aim of reversing 15 Haruhiko Kuroda and years of punishing monetary deflation and currency appreciation. This is Kikuo Iwata are reportedly the next step in the reinvigoration of the Japanese economy that we to be nominated by argued might follow the 2011 Tōhoku earthquake and tsunami (see Japan's Prime Minister "Meltdown in Japan" March 15, 2011). It is real. It is why Japan has been Shinzō Abe to be governor and deputy governor of the the best-performing major equity market year-to-date, and since the US BOJ. Both are stock market's bottom in June, 2012 (see the chart on the following page, interventionists and both and "2013 Outlook: Think Globally, Shrink Locally" January 14, 2013). are doves. This aggressively follows through on Abe's promise  At the Ministry of Finance, Kuroda was a strong advocate of to reform the BOJ and lift intervention to weaken the yen. Japan out of 15 years of  Iwata (not to be confused with former BOJ deputy governor deflation and currency appreciation, which has Kazumasa Iwata) is the Ben Bernanke of Japan -- an academic punished the critical export with an eclectic approach to policy embracing untraditional tools. sector. Markets have  Both are aware, as is Abe, that Japan's persistent mild deflation -- rightly feared that Abe while the rest of the world underwent mild inflation -- strengthened won't follow through as a the yen via purchasing power parity (please see the chart below). reformer, but on this decision he has -- and in the face of diplomatic — Japan CPI deflation versus US — Dollar depreciation versus yen pressure from the G-20. Based at zero as of October 1998, the all-time high for Japan's CPI We continue to expect Japan's equity market to 20% outperform the US, and the yen to depreciate against 10% the dollar.at we have warned about. 0% [Strategy Dashboard home] -10%

-20%

-30%

-40% Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Source: Bloomberg, TrendMacro calculations

Copyright 2013 Trend Macrolytics LLC. All rights reserved. This document is not to be forwarded to individuals or organizations not authorized by Trend Macrolytics LLC to receive it. For information purposes only; not to be deemed to be recommendations for buying or selling specific securities or to constitute personalized investment advice. Derived from sources deemed to be reliable, but no warranty is made as to accuracy.

 This currency strengthening has been particularly damaging to Contact Japan's growth, because productivity is so unevenly distributed TrendMacro across the economy. Inward-looking sectors such as retail, wholesale and agriculture have languished behind protectionist On the web at trendmacro.com walls. The "Japanese miracle" was due entirely to the outward- facing export sector, honed to excellence by intense global Follow us on Twitter at competition. Inward looking sectors are indifferent to exchange twitter.com/TweetMacro rates, but exporters are not -- so the last 15 deflationary years of currency appreciation have singled out Japan's growth engine for Donald Luskin Chicago IL punishment. 312 273 6766  We are not advocating inflation or currency devaluation, per se. [email protected] They are not keys to growth. But in Japan's case both are appropriate and essential, because they reverse 15 years of policy Thomas Demas Charlotte NC error in the opposite direction. 704 552 3625  Neither do we mean to imply that correcting its deflationary error [email protected] will cure all Japan's economic problems. But thinking at the margin, whatever else may be wrong with Japan, correcting this one large Lorcan Roche Kelly Sixmilebridge Ireland error -- especially as money touches the very platform of any 617 600 6969 economy -- will likely make a meaningful difference. [email protected]  The biggest risk for Japan is always that its leaders won't follow through. During Japan's two-plus lost decades, there have been [About us] many disappointments. It is encouraging, at least, that in the face of diplomatic pressure from the G-20 opposing Japan's small down payment on currency devaluation over the last three months -- to which Abe seemed to succumb last week -- he is going ahead with these two very aggressive appointments to the BOJ.

Equity market performance  YTD  From 6/1/12 US bottom Price return, local currency

+35.9%

+27.7%

+21.6% +20.9% +18.3%

+10.3% +8.4% +6.0% +1.5% +1.9%

US UK Germany Japan China Source: Bloomberg, TrendMacro calculations

Bottom line

Haruhiko Kuroda and Kikuo Iwata are reportedly to be nominated by Japan's Prime Minister Shinzō Abe to be governor and deputy governor of the BOJ. Both are interventionists and both are doves. This aggressively

follows through on Abe's promise to reform the BOJ and lift Japan out of 15 years of deflation and currency appreciation, which has punished the critical export sector. Markets have rightly feared that Abe won't follow through as a reformer, but on this decision he has -- and in the face of diplomatic pressure from the G-20. We continue to expect Japan's equity market to outperform the US, and the yen to depreciate against the dollar.