Will the Yen Lose its “Safe Haven” Status as Japan’s Economy Deteriorates?
By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report
Historically speaking, the Japanese yen has proved to be a safe haven against global turmoil. Right now, however, Japan’s economy is among the worst hit of all the global powers. It is ill prepared to weather the global storm and it’s falling like a rock.
That’s why, this time around, as Japan’s economy falls away, I think there’s a very good chance the yen could drop as well.
Obviously, this would be very bad news for the huge numbers of speculators and institutions that have literally bet their existence on yen-based hedging strategies. But while a freefall in the yen would be a surprise to those institutional players, it would be about par for the course in my book, given the current state of the ongoing global financial crisis.
As Money Morning has reported, hedge funds have so far unwound gold, real estate, easy-to-sell stocks and other asset classes – so why shouldn’t they unwind currencies at some point, too? The same can be said for banks and other financial institutions currently embroiled in the global financial fiasco. With redemptions mounting, continued malfeasance like the $8 billion Stanford Financial scandal coming to light, and the credit markets still essentially locked-up tight, it’s not an unreasonable expectation.
Traditionally, analysts have looked to current-account balance statistics as a guidepost of sorts when the going gets tough. Specifically, analysts like to study surpluses on net foreign assets because those figures have historically indicated which currencies are expected to perform better during times of crisis.
The theory is that the higher the surplus, the more incentive a nation (and the companies in it) have to “repatriate” assets – that is, to bring them home. Therefore, traders tend to go “long” on the strongest, while simultaneously abandoning the weakest – or even shorting them outright.
And they have in record numbers. According to the Bank of Japan (BOJ), the yen remains near the highest nominal trade-weighted level it’s posted since November 2001. And while you’d think there would be some reduction in this “safety first” view of the yen – especially given recent U.S. announcements regarding the stimulus package – the fact is that there really haven’t been any serious reductions in the net-long yen position.
Indeed, the latest data from DanskeBank A/S shows that, in recent weeks, speculative investors have only reduced net long Japanese yen positions to some $6 billion dollars. It also reflects that traders tracked by the U.S. Commodity Futures Trading Commission (CFTC) remain net short all other major currency pairs which directly contradicts what Washington thinks and is telling the public about a recovery.
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In fact, data drawn from the CFTC suggests that not only is the yen still viewed as a safe-haven currency, but that traders don’t buy into a U.S. recovery. In fact, traders are actively betting against a global recovery, at least as far as the major currency trading pairs are concerned.
There’s no similar data available from China, since its currency is partially blocked at the moment, but I’m hearing from traders all over the world that they’re assembling large-scale positions in China’s renminbi (yuan). If that’s true, this development will support my long-held contention that China is the real key to solving this mess, and my belief that China’s currency is poised to become every bit as viable as the dollar or the yen – if not more so, given the current global financial crisis.
The problem is that money is still flowing out of Japan and into foreign equities and bonds when it should still be flowing in. Consequently, some people like the institutional traders and speculators who have assembled the more than $6 billion in long positions in the Japanese yen argue that this is a temporary happenstance and one that, in fact, creates an even greater incentive to eventually repatriate the assets.
But I’m not so sure.
For one thing, the fact that “everybody” expects a stronger yen is the sort of contra-indicator that raises the hair on the back of my neck. Anytime the markets have such unified, blanket expectations, the unthinkable becomes possible, particularly if what everybody believes appears in print.
To illustrate what I mean, allow me to turn to the vaunted “magazine cover-story indicator,” which actually has a statistical basis as a contrarian warning.
Two of my favorite examples include the 1999 Economist cover story, “Drowning in Oil,” which stated that crude oil would fall to between $5 and $10 a barrel, and remain there for the next decade, and the infamous 1979 Business Week cover story, “The Death of Equities.” Less than a year later after the former was published, oil was trading at more than $25 a barrel. As for the latter, it preceded one of the greatest bull market run-ups in history.
Then there’s the fact that the Japanese economy is suffering its worst economic contraction in 35 years, and a recession that may be the worst in 50 years. According to Japan’s Ministry of Finance, the country’s industrial production is tanking to the tune of 30% this year, while its gross domestic product (GDP) may plummet 12% in a mere 12 months.
While this is unfolding, exports plunged thanks to non-existent overseas demand for the cars and electronics that have long been the mainstay of Japan’s industrial might. Overall, shipments to the United States – long Japan’s trading partner of choice – have plunged a staggering 34%.
The Wall Street Journal recently reported that Japan is running its first trade deficits in a generation – five months in a row at last count. This is especially problematic because Japan and China – together with South Korea – are the world’s largest purchasers of U.S. debt.
So at a time when the United States is trying to save its financial system and jump-start its economy by pumping trillions of dollars into the world financial system – and desperately needs global buyers to buy this new debt so that it can forge ahead with its rescue plans – Japan may not have the financial wherewithal to help make this happen. And China and South Korea may simply elect not to buy any more.
By all accounts, the fallout of all this turmoil is staggering. Japan’s economy may contract by 4.6% in 2009, Kyohei Morita, chief economist for Barclay’s Capital (ADR: BCS), told BusinessWeek recently.
Toyota Motor Corp. (ADR: TM) is projecting a worsening situation and a string of mounting losses that will be the first since 1938. Every single digit of yen appreciation is projected to cost the company an additional $450 million in operating losses.
According to The Tokyo Shinbun, more than 30% of Japan’s prefectures (governmental bodies larger than cities, towns, and villages) have already implemented emergency economic measures of their own. Overall, unemployment rose to 4.4% in December, the worst such figure recorded in 42 years. Tent cities are growing and many public parks are now overflowing with homeless people – something I recall seeing during the depths of Japan’s last “Lost Decade.”
My friends tell me that factories in the normally highly industrialized Osaka area have shifted to 15-day-a-month production schedules, and many salarymen (Japan’s iconic office superheroes) are being encouraged to seek “arubaito” – or part-time work – to make ends meet. And those are the people who are still fortunate to have jobs. My mother-in-law tells me that it’s becoming increasingly common to see these workers serving noodles or working in department stores, doing jobs that have historically been done by college kids.
Things are so bad that Prime Minister Taro Aso has an unprecedented approval rating of less than 10% and many normally respectful Japanese, including my ultra-reserved father-in-law, refer to him as an “uneducated blockhead.”
I could go on, but I think you get the picture. It’s bleak and getting worse by the day in a nation that I have lived in during much of the last 20 years and come to love.
That’s why shorting the yen may wind up being one of the most fundamentally successful – and admittedly contrarian – investment choices we can make in today’s mad markets.
I’ll be home in Kyoto in a few months and look forward reporting what I find immediately.
News and Related Story Links:
- Money Morning:
Financial Crisis May be Creating the Best Investment Opportunities of our Lifetime, Money Morning Expert Says. - News Analysis:
Hedge Funds Have Another $200 Billion to go to Complete Their “De-leveraging.” - Wikipedia:
Prefectures. - Money Morning News Analysis:
Stanford Scandal Ignites Bank Runs in Latin America. - Wikipedia:
current-account balances. - Money Morning:
Massive China Stimulus is Viewed by China Expert as a Key Attempt to Help the West. - The Financial Analysts’ Journal:
Are Cover Stories Effective Contrarian Indicators? - Money Morning Special Report (Part I of II):
The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it . - Wikipedia:
Taro Aso. - Money Morning Special Report (Part II of II):
The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it for Profit - Products:
Keith Fitz-Gerald – Time Trader Pro
Comment by John on 24 February 2009:
Keith, You are so right about the deteriorating Japanese economy. But let me also tell you this:
First, Japan has never been run on an economic model that is taught in business schools. The supply vs. demand rationale is out the window. Prices in Japan are out of whack. When demand declines, they increase prices to make up for the slack rather than reduce prices to increase supply to make up for the shortfall. They operate completely contrary to conventional rules. Very naive. Only recently, have you seen some prices come down. But in this country they don’t think with their head. They just follow what others are doing. It is all group oriented. No one wants to be ostracized in this culture.
Second, Japan’s population is facing something most countries have never anticipated. Yes, a declining one. You cannot have long term economic growth with a population currently at around 120 million projected in 50 years to be less than 80 million.
Let’s face it. Japan has no direction of its own. Look at the Nikkei. Its average is pretty much aligned with the Dow. Just a follower.
Furthermore, with the Nikkei hitting over 38,000 on the last business day in 1989 and today it is just above 7000 speaks volumes.
The yen is way overvalued. It just can’t make much sense being below 125 yen to the dollar. Frankly, it ought to be 200 yen to the dollar.
I think Obama is making a serious mistake to inject so much money into the US economy without allowing the market time to adjust accordingly. While this may be called the trillion dollar mistake, Japan not following a rational business model is far worse and should and will cost the value of the yen quite dearly. Calling Japan’s failure in re-energizing its economy since the bubble burst in 1990 a ‘lost decade’ is an understatement. As far as I can see in the future it has no way of bouncing back. Not with the way they conduct business. Japan may learn a costly lesson with all this. And the yen should and will reflect that sooner than later.
Comment by Paul Coote on 24 February 2009:
Keith, this report on Japan is frightening. As we all know, the aberrations in the Japanese Economy that led to Japan,s recession is similar to the US economic meltdown. If the tributaries to the US economy continues to fall apart, can you imagine the continued financial mayhem that still awaits us on the horizon.
Is this an ominous sign that the Us has a far way to go?
I do look forward to your follow-up report on Japan and the present administration needs to pay close attention to this report.
Comment by Cesar Cabrera on 24 February 2009:
Further more to this situation, No one is really looking to the next 3 or 4 years to come. Climate changes are going to even worsen the actual economic situation.
It seems impossible, but if the world big economies start working hand to hand in order to solve this problem, we might be able to overcome this situation.
Best regards,
Cesar.
Comment by stan on 24 February 2009:
This is a very interesting post. The Japanese economy is receiving a good deal of attention in the US media right now because of the comparisons – right or wrong – to the US’s current economic situation and Japan’s “lost decade” in the 90s. This clip from Newsy (http://www.newsy.com/videos/japan_s_lessons_for_u_s_economy/) focuses on what the US can learn from Japan’s experience. One Republican strategist featured in the clip repeats the GOP talking point that you can’t raise taxes on individuals and corporations in the midst of a depression… like Japan did in the 90s. Perhaps you could comment on this statement. Is it true or not? And if so, why? I enjoyed your nuanced post on the Yen, and was hoping you could provide some further insight on the questions I mentioned above. Thanks.
Comment by Doug Flynn on 25 February 2009:
To elaborate further on your concerns that should China &
Japan (the largest buyers of US Treasury debt) stop purchasing, I just read the following…”Indeed, troubling for the US fixed-income market is the sizable, single-month net
sale of Treasury Bonds by China and Japan during November.
The Chinese dumped -$9.16 billion of T-Bonds and T-Notes,
a glaring reversal relative to net purchases of $46 billion over
the previous four months…while Japanese sold another -$7.7
billion of Treasuries in November, to mark the fourth consecu-
tive monthly net sale, and a cumulative liquidation of -$38.5
billion since the beginning of August.
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