Posts Tagged ‘yen’

Business setbacks in the land of the Rising Sun

Sunday, December 14th, 2008

We quoted Marc Faber at Is the Warren Buffett way dead?:

Above I tried to show the existing connectivity between global liquidity (coming from the US current account deficit), asset markets, and currency movements. To navigate successfully between all these volatile and often unpredictable market movements you need to be a genius.

As we explained before in Real economy suffers while financial markets stuff around with prices, volatile movement in prices in the context of market movements will have tangible impacts on the real economy. One of the market movements is currency flow. Over the past few months, there had been a flight towards the US dollar, which in turn had a flight towards the Japanese yen through the reversal of the yen carry trade (we first mentioned the carry trade in Another source of potential financial crisis?reversal of yen carry trade). These currency movements resulted in a rising US dollar relative to all the other major currencies (except the yen) and the rise of the yen relative to the US dollar. Indeed, over the past 3 months, the US dollar had depreciated around 17% against the yen.

The rapidly rising yen is wrecking havoc on the Japanese export sector, which in turn has a serious effect on the Japanese economy. For example, as this news article from the Asahi Shimbun reported, Toyota budgeted a yen exchange rate of around 100 yen to 1 US dollar for the second half of this fiscal year to March next year. But for every 1 yen that appreciated against the US dollar, Toyota loses 400 billion yen of income per year. This unexpected appreciation of the yen is a setback for Toyota. Other Japanese export companies are finding themselves in the same predicament.

Japan was finally climbing out of the 18 long years of economic stagnation when the GFC struck. Now, they are falling back into the hole again. Looks like the Japanese are in the same boat as the Chinese with regards to their export sector.

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Posted in Market Observations | 10 Comments »

Is the real reason behind the Shanghai rout due to something else?

Wednesday, February 28th, 2007

Last night, the Shanghai casino (stock market) fell in a stampede of panic, triggering a worldwide sell-off. For us, we are not the least surprised to see that. In fact, as we advised back in January this year in Discerning a stock market bubble, that was the time to exit the Chinese stock market. Coincidentally, within less than a week after our warning, it corrected. Yesterday was the second major correction within a month.

Now that the dust had settled, we are wondering why did a Chinese sell-off create such a ripple effect to the rest of the world?s stock market. The previous correction of 4.92% at the end of January was hardly news at all. Surely, the magnitude of yesterday?s correction, though greater than the previous one, should not be the reason for such a contagion?

The ?official? reason for this market correction was that a rumour of the Chinese government?s intention to crackdown on speculation triggered the sell-off in Shanghai. While this reason may be true in the general sense, we guess nobody knows the real underlying reason. Here, we offer our speculative hunch (which require more investigation to confirm)?this may have something to do with the yen carry trade. Back in January, in Liquidity?Global Markets Face `Severe Correction,? Faber Says, we mentioned about Marc Faber?s prediction about a coming severe correction in all assets class in the coming months. Though he did not fully explain the underlying reason behind this prediction, he did mention about the idea of liquidity (see Liquidity?Global Markets Face `Severe Correction,? Faber Says on the concept of liquidity). Thus, we believe that when he made that prediction, he saw a coming liquidity crunch in the days ahead. Back in Liquidity?Global Markets Face `Severe Correction,? Faber Says, we did ask this thought provoking question: Are we now ripe for a contraction in liquidity?

A week ago, in Another source of potential financial crisis?reversal of yen carry trade, we did mention about the ramifications of a potential disorderly reversal of the yen carry trade. Much of the world?s liquidity can find its source in Japan through its near zero interest rate policy. However, it is obvious that the Japanese will normalise their interest rates sooner or later, which means the yen carry trade will have to end one day. The question is, whether this end comes through an orderly or a disorderly process. A disorderly process means that non-Japanese assets will have to be quickly liquidated and yen re-purchased to pay back the yen-denominated credit. This will result in a rapidly falling non-Japanese asset prices and a swiftly appreciating yen. Recently, Japan had raised its interest rates to 0.5%. Also, Japanese inflation is picking up and their stock market is trending up. The indications point towards the Japanese tightening up their liquidity. Perhaps someone reversing their yen carry trade on frothy Chinese stocks started the Shanghai rout?

Anyway, this is just our hunch?we are prepared to be proven wrong on this. But if our hunch is right, this means that there will be more corrections to come. That may explain the severe reaction of the global stock market.

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Another source of potential financial crisis?reversal of yen carry trade

Monday, February 19th, 2007

Interest rates in Japan had been zero for many years. It was only until recently that it had risen to only 0.25%. Such an unusual financial phenomenon sparked an interesting money-making opportunity?the yen carry trade. Basically, in a yen carry trade, you borrow money in Japan (where the interest rate was zero and is now 0.25%) and lend in countries with much higher interest rates. The interest rates differential makes up your profit. There are many ways to play with the yen carry trade. The most conservative way is to invest the borrowed money in US Treasuries. No doubt, there will be some hedge funds who want to achieve higher but more risky returns by investing in more risky assets such as stocks and Shanghai real estate.

What is the risk with this kind of strategy? Well, this strategy counts on the exchange-rate of yen not rising. A rising yen can wipe out your interest rates differential profits, even possible resulting in losses. Thus, the next crucial question is: what can result in an appreciation of the yen? For 16 years, Japan lived under the threat of deflation and economic malaise?that is the reason why the Japanese central bank made its money as cheap as possible (i.e. zero interest rate) in an attempt to counter such an economic threat. It is only until recently that the first lights of economic recovery can be seen. At this point in time, the Japanese economy is still dependent on exports to grow, which means that they have an interest to keep the value of yen low.

What will happen if the Japanese economy finally makes a confirmed recovery back into normality (there are signs that the Japanese economy may be recovering?read this report)? We can bet that Japanese interest rates will rise, thus putting a squeeze in the carry trade profit margins. More importantly, it means that the Japanese are finally willing to allow their yen to appreciate. Any appreciation of the yen will result in massive reversal of the yen carry trade, which in turn will trigger further appreciation of the yen, resulting in a self-reinforcing feedback loop. The danger right now is that a massive amount of yen are being borrowed (some experts says it is worth a trillion dollars), which in effect is a gigantic bet that the yen will not rise. A disorderly reversal of the yen carry trade will almost certainly mean that there will be losses in terms of billions of dollars, triggering yet another financial crisis. We will then see the collapse of many hedge funds.

The bad news is: This is just the beginning.

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