Good Questions for Noda

Over at Shisaku, Michael Cucek asks some good questions about what happens next. This one especially is a puzzler:

Does a rush to the bond market, heartened by Noda’s message of a reduction of Japan’s deficts (reducing the debt is not a realistic prospect) send the stock market into a tailspin?

It’s a good question but there are massive contradictions to deal with here. While sending out a message that basically says “we’ll increase the tax base (eventually) to reduce the deficit”, Noda is signalling that he’s in favour of weakening the Yen. In any rational world the Yen should be going to hell, and yet somehow (hmm, what could it be?! An export economy, importing the majority of it’s raw materials priced in dollars, perhaps?) the Yen, along with the Swiss Franc, is stronger than ever. The FT reports today that the Yen is now 47% higher against than it was in 2008. Ouch.

It seems things are not entirely reality based. The US and Europe are in a desperate race to the bottom, and Japan really can’t compete in the financial armageddon stakes. My guess is that Noda will be forced to live with a strong yen, and a high debt level. Meanwhile something with force of the PIIGS into a default, bondholders will (with bad grace) eat their loses, and lash out, bring down all sorts of mayhem on all our heads. At the end of all this Japan will still owe it’s citizens a bunch of money, but not much else will change there.

The adage about the futility of betting against the Yen is likely to hold a little longer…

Seven Charts and a Curious Conclusion

I’m confused. “Well”, i hear you say, “there’s a surprise!”

Since Uncle Ben announced it latest round of debt monetization (QE2) the dollar has strengthened against the Yen. Not by much, but it has been consistently in one direction. Obviously this will change now that i’ve mentioned it…

This article has (you guessed it) seven charts of the dollars performance against various currencies. I’ve never been able to get much out of, so called, technical analysis. In fact, it’s usually translated in my head to ‘testicle analysis’ as it seems to be only so much bollocks…

That being said, the following chart of dollar / yen since 1976 indicates to me that there is basically one relentless trend:

If you were going to bet on one thing based on that chart it would probably be that the yen is going to continue to strengthen against the dollar. The last couple of decades of deflation in Japan have provided some respite for the yen, but with the comparison being between a contracting US (with a massively negative trade balance, and a money printing, actively dollar debasing, Fed) and a moderately deflating Japan, it’s obvious that we’d be testing new lows.

All of which makes the following conclusion to the article:

The key take-away: A grossly weaker dollar is not an economically or politically acceptable proposition for the world. And trouble for the world economy represents trouble for the U.S. economy.

So, despite all of the bold projections of a continued rout in the dollar, these seven charts suggest the exact opposite outcome could be around the corner.

Wha?

The missing piece, in what i’ve said above, appears to be the following chart:

which shows the relative values of currencies (against the dollar?) The Yuan is the obvious standout here – over the period of the chart it has risen only modestly, which everything else (of import in the world of currencies) has headed for the roof. This makes chinese export (relatively) more (price) competitive.

The argument is presumably that this collective need for a strong dollar (it is after all the world reserve currency, not just the currency of the US) will override the desire of the US to devalue the dollar, to boost exports. I’d have more sympathy for this argument if the US was an export powerhouse, but that hasn’t been the case since the 50s, and there are only so many wars you can ferment to increase arms sales… and when something like 80% of your manufacturing base is in the “defence sector” that’s a reasonable consideration!

Thus far the collective desire for a strong dollar has not amounted to much, unless one assumes that it has been a case of attempting to ‘talk the dollar up’, an no real action has been taken.

There we are: i’m confused. The dollar is obviously weak and i can see no reason why it should not continue to weaken. However, it’s strengthening, and  people are convinced that this is to be expected.

Don’t know what to think… except that markets can’t be rational if they are based in the complex (and irrational) behaviours of traders following there hunches and muses!

Another Yen / Dollar Theory

There is a quite a lot of talk about the dollar carry trade. In essence this means that dollars are being used to buy assets (other currencies) with higher yields. This is, in effect, selling the dollar. This selling causes the value of the dollar to fall relative to the currency being bought. (I’m not sure if that part is right. It doesn’t seem right that selling the dollar and buying another asset would cause the value of the dollar to fall against all other currencies, so i’m assuming…)

If the yields for holding dollar denominated assets rise (stock market indexes, or bond yields, increase) the non-dollar assets are sold to buy these now higher yielding assets. The value of the dollar rises relative to the currency being sold. (similar caveat to above)

As the dollar carry trade is currently considered to be huge (larger than the yen carry trade that proceeded it!) the effect on the value of the dollar is large. However, the stock markets in the US have been rising for some nine (plus) months, which must temper some of the possible decline in the dollar. There are also different classes of risk, meaning that some of the money flowing around might consider the equity markets too risky, and would flow into government bonds (with higher yields than US treasuries). In all likelihood, given the general trend of massive public sector borrowing, there are lots of high yielding bonds out there to buy. If holding these bonds becomes too risky, the money will flow out again, back to lower yielding, but presumably safer assets (US Treasuries, for example).

Assuming that there is some kernel of truth in the above, it makes sense that the Yen is remaining stubbornly strong against the dollar, even while everyone and their dog is predicting japanese sovereign default. Yields on japanese government debt are low (because the debt is held in Japan …that’s not really an answer, but let us just say that it is possible for the MOF to borrow cheaply, just “because”) and other yen denominated assets are not attractive (deflation; would you want to buy a shrinking pie?!) Therefore, very few of the dollars that were sold resulted in yen being bought. And conversely, as these carry trades unwind, very little yen is being sold…

Having written all that down, i’m not convinced… all it says to me is that the yen is sort of in a no-mans-land, languishing in the doldrums, while the action happens elsewhere. Perhaps it’s just that with a positive trade balance, companies are constantly having to buy yen to repatriate revenue.

Relationship Reset?

This (fictional) piece is the best from my (limited) weekend reading:

The following fictional conversation never occurred in June 2009 between Treasury Secretary Tim Geithner and a Chinese negotiator named Cheng for the sale of U.S. assets, at least not that we know of. 

 — USA Fire Sale, 2nd Meeting, June 2009: Political capital call, iTulip.

Some of the ‘human rights’ stuff cuts a little close to the bone. It’s almost as if the Americans (i presume to be) writing this with that they had an authoritarian / repressive system to live under… there is, after all, no accounting for puritanical tastes.

Entertaining and informative. Sightseeing on the road to a financial brave new world!

After thought. A lot of what i’m reading reinforces my views that the Chinese (or more broadly Asia) is well aware of what it is doing, and will manage the descent of the West into a far more “equal” set of relationships over a relatively long period of time. Just like the frenzy of doomsaying around peak oil last year, our systems are a lot more flexible that it first appears – stretching them to the point of collapse takes time. This is presumably because we are highly adaptive, on mass easily manipulated, and delusional. It isn’t very encouraging, but it does go some way towards explaining why what appears to be a completely untenable situation can be strung out for so long. The obvious exception to this would be Gaia, which doesn’t really care how it kills us off, just as long as it shakes this fever.

Doom or Gloom?!

Doubt that’s a choice we’ll have to make…

As feared, stocks decline and bond yields rise, aka. a bond dislocation. <gulp>

It has begun. Today equities fell significantly and the “safe haven” bid was not large enough to overcome a deluge of selling. Yields rose. Again. This is not likely to be an isolated incident. This while happen with greater frequency and increasingly disruptive consequences.

Hmm. I’m still not convinced. There was a huge auction of 7 year bonds today, which might have distorted the market. For sure there is a lot of stress in the bond markets due to amazing volume of government debt… but one swallow doesn’t make a summer, and all that.

Keep watching!

The Financial Ninja (also linked via the image above) seems to have his eye on the ball:

Giddy talk of “green shoots” has completely drowned out a more sober and rational assessment of the global situation. Random statistical noise in various minor economic indicators have over the past two months resulted in wild exclamations of “the worst is definitely over”.

It most certainly is not.

Yet another blog worth following as we mosey along in this wicker basket… can you smell sulphur? Perhaps it’s just me.

Update: I was wrong about the 7 year auction being yesterday, it was today. Yesterday was an auction of 2 and 5 years. The 7 year auction went off smoothly. More evidence for continued randomness rather than being at the point of systemic collapse. In theory the short end of the bond market should be more resilient than the long end… patience!