Posts Tagged ‘deflation’

The strong Yen

Monday, November 30th, 2009
Japanese Yen

Japanese Yen

The Japanese recently made a new high, reaching levels unseen since 1995.

As a country depending a lot on finished good exports (Japan has no natural resources to export) since after World War II, the strength or weakness of its currency is a matter of national concern. When the Americans ruled and reorganized Japan in 1945, they created today’s Japanese Yen with a conversion rate of 360 Yen for one dollar.

Last Friday the Nippon currency reached 86.58, a fourteen years low and a long way from the initial rate set by the American. And this is getting closer to making an all time high.

This is bad news for the country which has suffered from deflation for the past decade. This is likely to continue with a stronger Yen making all imports cheaper. This is also bad news for local investors. On one hand the Japanese stock market never likes a strong Yen; on the other hand all financial derivatives based on getting cheap Yen financing including carry trades will suffer from a stronger Yen.

This situation illustrates the eternal debate about the merit and benefit of using a floating currency for a trading country. Japan let its currency floating completely during financial deregulation in the 80’s under pressure from the American. But the Big Brother in the North, China, has not fallen to similar pressure. And their exports are booming but their currency is not that strong.

A large part of China’s recent economic success and rise to the top of commercial leagues can be attributed to the weakness of the Renminbi. The Chinese engineered a massive devaluation of their currency in the 80’s and even though the Yuan is nowadays pegged at 6,83 after its recent appreciation, it is still a long way from its value of 1,50 in 1980.

The bottom line is that the currency policies employed by Japan and China in the past twenty years have been opposite in many respects, helping the gap shrink between these two countries. This simple notion can explain tremendous wealth creation in the Middle Kingdom with simultaneous wealth erosion in the Land of the Rising Sun.

As the Japanese officials are starting to show signs of concern after the latest Yen appreciation, it is going to be interesting to watch this next episode in the saga of Asian currencies.

Euro at a 2009 High on Dollar

Saturday, May 23rd, 2009

Since the end of 2008, the Euro has traded in a range 1.25-1.40, moving back and forth.

In the pas few weeks, the Euro has rallied steadily and crossed 1.40 for the first time in 2009. What is also apparent is the correlation with the rally of the U.S. stock market.

The U.S. market has been rallying smoothly (with lower volatility) as of late, and for now momentum players are ruling the Euro. This is a standard type of trade with a mini trend started from a strong low (as the recent low is stronger than previous lows), plus the possibility to test a 6-month and a 9-month ranges, and to go all the way to the next magnet price of 1.50.

With respect to fundamental news, one reason for the rally is the recent decision by Standard & Poor’s to take a negative outlook on the triple-A rating of the U.K. This led to the belief that the triple-A rating of the U.S.A. could or should also be put on the same watch list.

Between you and me, this is ludicrous, as there is no better credit in the World than the U.S. Government. This is why it is called risk-free rate in Economics and Finance classes. Downgrading such rating is totally meaningless, as it just means all other credits should be shifted down as well. So this sounds more like an excuse to justify the rally than anything else, and confirms the momentum play theory.

In the other main currency pair, the Yen has also being very strong lately, confirming the scenario of overall medium-term U.S. dollar weakness, even though it corrected by late Friday. The dollar has also been weak versus the British Pound and the Swiss franc.

How is this dollar weakness playing in the bigger picture? For many months, part of the financial and forex business community has been concerned with the massive influx of liquidity created by World Central Banks, especially the Federal Reserve.

Printing money in times of crisis is not a new medicine, but the Obama’s administration is using it like there is no tomorrow. Creating money has always led to inflation since the first King of Antiquity started it. Only the future will tell us if this time is a different time. Or if this time there are strong enough counter forces such as a globalization induced deflationary wave to eradicate this mounting inflation.

For now, most economic indicators show inflation insouciance, such as the spread between the yield on the 10-year inflation-protected Treasury and the regular 10-year Treasury, which suggests inflation at 1.78%. But a number of smart money and well informed investors have been piling into Gold this year, betting that inflation will pop its ugly head at some point.