So What about the World's Second Biggest Economy?

The Japanese are getting more than their money's worth from Prime Minister Taro Aso's recent visit to London. Trips by prime ministers to meetings like last week's Group of 20 are normally complete junkets. But it would appear that the magic spending wand was brought out during the course of these meetings.

It seems Prime Minister Aso got a bit of religion from his chats in London with U.S. President Barack Obama, U.K. Prime Minister Gordon Brown and 17 other leaders. Aso's new stimulus package, amounting to 15.4 trillion yen ($153 billion), is proof enough of that. Two key points are worth noting here. One, Japan will now spend a total of 25 trillion yen, or about USD 250 billion, which seems to indicate that it's getting serious about taming the recession. Second, Asia's spending efforts are putting an even greater onus on European nations reluctant to do more.

Right now, this is a "do-or-die" moment for the world's second-biggest economy. Japan has been among the hardest-hit developed nations because of a heavy reliance on exports. Aso's two previous packages failed to excite markets or consumers. Hopefully for Aso, the third time is the charm and not a strike out.

Last year's popular argument that Japan was a haven from global turmoil died a quick death in the past three months as the JPY weakened to over 100 from 87.13 against the USD, a 13 percent drop in a quarter and over 50 percent if annualized - inherently meaning a slowdown in the decline is due. The ruling Liberal Democratic Party's latest package amounts to about 3 percent of gross domestic product. Put together with Aso's previous two, Japan will be spending about 5 percent of GDP - a ratio comparable to U.S. stimulus plans. Rather than spreading out the spending over three years as with previous plans, Japan's latest will occur in one year. If implemented competently, these steps could stabilize the domestic economy and stop the bleeding in labor markets. However, early criticism hovers around the fact that, like the U.S. stimulus, is a series of transfer payments and not real demand generation. Furthermore, it does not address the very serious problem of Japanese demographics of a huge aging population and near zero-percent population growth rate and low confidence in their pension system. Additionally, recent data showed business sentiment plunged to a record low and suggested unemployment will rise markedly, all contributing to declining JPY.

Does the second largest economy need more spending? Probably. The amount could be considerable thanks to the liquidity trap in which the Bank of Japan finds itself. For example, the BOJ would need to get its 0.1 percent benchmark rate into the minus 4 percent to minus 5 percent range to stabilize growth. In a credit crisis, fiscal policy must lead the charge. Japan's bond vigilantes aren't happy, of course. Yields surged to their highest level since November as traders brace for as much as 11 trillion yen of bonds to fund the spending.

It's quite a contrast with Europe. In London, German Chancellor Angela Merkel was pressured to spend more to attack the country's worst recession in more than 60 years. Finance Minister Peer Steinbrueck argues Germany doesn't need a third stimulus package after spending 82 billion euros ($110 billion) in the previous two rounds. France and other European economies haven't spent as much as many economists would like.

Markets responded well to reports of Japan's package. The Nikkei 225 Stock Average's erased its loss on the year, rising 2.5 percent this week. The index is up 1.18 percent on the year after reaching a 26-year low on March 10. The JPY on the other hand is still beholden to high velocity capital flows based on risk aversion trades. However, with the U.S. stock market perhaps finding a bottom along with commodity prices rising over 25 percent in the past quarter, the risk aversion trade has hit the JPY hard, now over 100. Given the export demise, this is only good news for the Japanese economy and we wouldn't be surprised to see the next test targets at 104 without much interference should the USD continue to strengthen. What we can conclude is that Japan's leaders are finally realizing the depth of the economy's challenges, and that's good news for Asia.