The Fed has the powers to alter short term rates. Long term rates such as those of the 10 year treasuries, are set by the market. Therefore, these rates are believable since they are not manipulated by the Fed or politicians.
Japan has been in a deflationary environment now for over a decade. The Nikkei Index peaked at nearly 39000 in Dec. 1989. The Japanese have been creating liquidity by lowering interest rates. Their 10 year bond yielded 8.43% at approximately the time Nikkei peaked. These days the Japanese 10 year bond yields a paltry 1% approximately. So much for the liquidity intervention by the Bank of Japan; today the Nikkei stands at around 9000 with deflation showing no sign of easing its grip.
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Large global imbalances both between and within nations have been well documented over the last decade and have continued to become more misaligned. While most commentators have argued why a Japanese style stagflationary reversion to the mean is unlikely, it is both the most wanted and mostly likely outcome of current imbalances. It is most wanted by policy makers and most likely for the reason that it’s being targeted.
The Japanese economic model over the last 20 years is the best alternative for the Federal Reserve and other government policy makers because the alternatives are too great and terrible to imagine. If the government discontinued its intervention, the credit expansion created during the last 30 years would be completely reversed resulting in massive defaults to the point at which banking as a whole would discontinue. This is the natural force of the market. On the other hand, if the economy stalls and the government intervenes with too much force too quickly, then confidence in currencies would collapse and global hyperinflation would ensue. Either of these scenarios would risk a breakdown in society and likely change in government regime.
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The fact that it won't intervene reflects two things. Japanese intervention style is typically about overwhemlming the market in size. This contrasts to the US traditional approach which is more about finesse than size-- catching the market wrong footed rather than beating it back. Secondly, Japanese officials are really at a loss and have little confidence.
On Friday, the dollar jumped to JPY85.20 to set a new high for the week and nick the 20-day moving average (~JPY85.10). It will take a move back above JPY86 to cause the yen bulls to re-think and this does not seem likely in the near-term.
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I wrote a few days ago that I thought we were seeing evidence of growing instability in the FX markets. The problem is with the “Strongs”. The Yen and the CHF are both at near records against the dollar and they are at records versus the Euro. These records are a cash machine for the FX crowd. The CBs know it and they do not like it.
IMHO the only thing that is going to stop the cycle of the Strongs getting stronger is coordinated intervention where the NY Fed took an active and visible role. We are not going to get that. I think that is an important conclusion. If that is not the case then the door is open for continued (irregular) strength of the strong pair. Consider this from Bloomberg:
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A news wire now cited three "unnamed sources" suggesting that US opposition to intervention is preventing unilateral BOJ intervention. Really ? This seems to exaggerated the US influence over Japan. The US did not seem to look at the massive BOJ intervention in late 2003 and early 2004 favorably, yet it took place. That is to say if the political will was stronger, US distaste/objections to intervention would be overcome. The yen's rise is not simply against the dollar, as the performance of euro-yen clearly illustrates. The yen has appreciated by about 10.5% against the dollar this year and about 21% against euro. Since the end of Q1, the yen has appreciated by around 14% on a trade-weighted basis and 40% in the past two years.
Ozawa, who is challenging Kan in the DPJ leadership contest toward the middle of the month has been arguing in favor of intervention. But when he was cabinet secretary (until recently) he reportedly was not pressing this. In any event, polls show Kan clearly ahead.
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Japan
Software
• China enterprise software maker Pansoft Co. Ltd (PSOF) will invest 18 million yuan (US$2.7 million) to set up a joint venture (JV) with two Japanese companies in order to enter Japan's mobile software outsourcing market. Pansoft will hold an 80 percent stake in the JV named Pansoft (Japan) Co. Ltd. with the remaining stakes going to Management Information Center Co. Ltd. (MIC) and Seven Colors Corp. The JV will test 3G mobile software for Sharp Corp. at Pansoft's headquarters in Jinan City, Shandong Province. The JV is the first step of what is potentially a major move for Pansoft into mobile software outsourcing for the Japanese market, said Pansoft CEO Hugh Wang. Pansoft Japan currently accounts for 10 to 20 percent of Sharp's software testing business. Hugh anticipates that Pansoft will be able to secure more outsourcing contracts from Sharp and other Japanese IT companies in future due to their competitive prices.
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The Bank of Japan held an unscheduled interest rate meeting during the early hours of the Asian session Monday, but rumors about it surfaced even as of late Friday, taking out some of its surprise element.
The unscheduled meeting comes in a very difficult moment for the Bank of Japan: the Usd/Jpy is trading at the lowest value in 15 years despite numerous verbal interventions in the currency market, while the Japanese CPI is standing at the dangerous level of -0.9%.
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The Yen has been the strongest currency of 2010, benefiting from the overall downtrend in risk assets brought on by the EU sovereign debt/banking crisis and slowing growth in most of the developed world and China.
Most recently, markets saw Monday’s announced additional stimulus as too little too late to undermine the JPY, and took it as a sign that the BoJ still lacked the will to intervene and weaken the Yen, which then continued to rise, with the USDJPY again falling below 85. As we’ve argued in the past, that is probably because without US and EU cooperation, currently unavailable, the BoJ is unlikely to achieve lasting results.
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My position over the last 2 years has been as follows: this is a Main Street debt crisis. I have been highly critical of the government’s incessant interventionist policies over the last few years largely because they ignore the actual problems at hand. First it was Mr. Bernanke saving the banks because he believed the credit crisis started with the banking sector. The great monetarist gaffe ensued. Tim Geithner piled on with the PPIP. FASB jumped on board the bank rescue plan by altering the accounting rules. And then the icing on the cake was the Recovery Act, which, in my opinion, just shoveled money into the hole that had become the output gap, without actually trying to target the real cause of the crisis – those burdened by the debt. In essence, the various bailouts primarily targeted everyone except the people who really needed it.
A year ago I posted a story citing the many reasons why we were sinking into the deflationary Japanese trap. The primary flaw with the US response to the crisis was that we never actually confronted the problem at hand. I have often cited Japanese economists such as Richard Koo who appear to have a good grasp on the problems in Japan and now in the USA. In this case, I cited Keiichiro Kobayashi who is now looking most prescient:
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In the overnight markets, the Nikkei average fell some 3.6% to close at its lowest level in more than a year. This came as a result of the emergency Japanese monetary policy meeting that failed to produce measures that would cause Yen weakening. There has been much speculation over intervention in the currency, which hasn’t been done since 2004.
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Japan Monday attempted to halt the surging yen by outlining stimulus measures and easing its monetary policy, but markets failed to respond.
Prime Minister Naoto Kan detailed a plan to implement a new stimulus program by the end of September, and the Bank of Japan announced after an emergency meeting that it would introduce new loan programs to encourage bank lending to consumers.
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"Japan Battles Soaring Yen," is the title of the front-page feature article in today's WSJ. The yen recently strengthened to 84 versus the dollar, the strongest level seen since the yen briefly flirted with 80 back in April '95. The yen has been the strongest currency in the world over the past 40 years, rising from just under 400 yen to the dollar in the early 1970s, to 85 today.
The inherent strength of the yen is also seen in this second chart, which shows the value of gold in dollars, euros, and yen. Since 1977, gold has risen about seven-fold in dollar terms, about five-fold in euro terms (linking the euro to the DM), and only two and a half-fold in yen terms. The yen's long-term strength is not so much due to some mysterious force, as it is due to Japan's central bank. Japan's currency is strongest relative to gold and other currencies because the Bank of Japan has done a much better job of keeping inflation low than any other central bank.
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For many in the U.S., a strong currency sounds like a nice problem to have. A firm greenback effectively reduces the cost of flat-screen TV’s from Asia and makes overseas vacations a little more affordable. In reality, however, currency strength can be an significant obstacle to economic growth, especially for export-dependent economies. No one knows that better than Naoto Kan, the Prime Minister of Japan who recently took office in a country that has fallen into a decades-long economic malaise, thanks in no small part to a stubbornly strong currency.
With general risk aversion running high, investors have flocked towards safe haven investments. And despite Japan’s economic struggles the yen still stands out as a safe harbor during economic storms, especially with the U.S. recovery showing signs of cracking. The yen recently reached a level of about 83.60 per dollar, that highest value for the Japanese currency in more than 15 years. That prompted calls for the government to step in provide relief , as countless Japanese executives expressed opinions that current exchange rates make the economics of their businesses incredibly challenging.
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By Bryan McCormick
By the time our markets start the pre-market on Monday, they are likely to have reacted to a special emergency policy meeting in Japan. The meeting will focus on ways to lower the value of the yen, which is seen as hurting exports. At time of writing on Sunday evening, the Nikkei and US stock index futures were both responding positively to the news. If this situation holds, it will be good news for the bulls.
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David Rosenberg, chief economist for Gluskin Sheff (Toronto), had an interesting graph the other day showing how well the yield of the U.S. 10-year Treasury bond tracked with the Nikkei 225 index (Japan).
This is an excellent example to show how widely correlations can vary between different time periods. The data has been analyzed year by year since (and including) 2004 through August 26, 2010. The results are displayed in the following graph:
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In an effort to get its economy out of a two-decade tailspin, Japan is looking to the west. But not to the economies of Western countries like the United States. Instead, it is looking west over the Sea of Japan - to China.
The financial crisis taught many Japanese businesses the dangers of over-reliance on the U.S. and Europe. Besides, it has a new cash cow.
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On Tuesday, I was on CCTV News’ Dialogue program, talking about the implications of China surpassing Japan to become the world’s 2nd largest economy. Martin Jacques, author of When China Rules the World, was one of my fellow guests, via satellite. You can watch the show here.
One of the main topics we discussed was China’s apparent discomfort at the news. Rather than celebrating the accomplishment, the Chinese leadership has been eager to issue cautions and caveats. Earlier this week, Barbara Demick of the Los Angeles Times asked me about the reasons behind this reaction:
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The Yen is at a 15-year high. This is a sign of severe dislocation in the global markets. Other notable milestones include Treasuries at record low yields and housing sales at 1995 levels.
You wouldn't know pressures in the global economy were this extreme from looking at the trading ranges the S&P 500, MSCI emerging market index, gold, and oil have been trading in.
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Japan is caught in a deflationary spiral that has left its government scratching its head in search of a solution and its ETFs in the doldrums. The rejuvenated Japanese yen isn’t helping things, either.
The Japanese economy only expanded 0.1% in the second quarter and was overtaken by China as the world’s new number two economy, reports Hiroko Tabuchi for The New York Times. The Japanese yen is also appreciating, diminishing the the returns of Japan’s exports. There is currently little or no talk of currency intervention within the government.
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The Nikkei closed at 8995 last night, 77% below its final price in December 1989. The rising value of the yen is what is causing the stock market drop. The yen just hit a 15-year high against the dollar and 9-year high against the euro. A richly valued yen is a big negative for Japan's export-based economy.
Japan has been trying to grapple with its real estate and stock market bubbles from the 1980s for over twenty years now. Its approach has been a zero interest rate policy (ZIRP) and an unending serious of stimulus programs (it was recently announced yet another one is being considered). The United States is currently following these same failed policies, but Washington is expecting that somehow they will work here. It is true that the U.S. real estate and stock bubbles in the 1990s and early 2000s were not nearly as bad as those that took place in Japan earlier. So maybe it won't take U.S. stocks 19 years to hit their lows (that would be 2026 by the way) as was the case for the Nikkei - or at least the case for the Nikkei so far. It cannot be said for certain that the 6695 low in March 2009 will hold.
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