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Welcome to the Currency War, Part 7: The Zero Sum Game

Based on the past few weeks’ stock market action, Japan’s decision to flood the world with yen looks like a raging success. It’s not of course. Here’s a cogent take on the subject from ex-hedge fund manager Bruce Krasting:

Japan’s Gains Are Losses For Everyone Else
My daughter called last night, she’s made her reservations for a honeymoon in Japan. Six months ago she was leaning on going to Thailand, but the cost of a trip to Japan has fallen so sharply, that she was able to afford the cost of a visit to beautiful Tokyo. She’s delighted.

The dollar cost of a hotel in Tokyo has fallen by a very significant 25% in just a half-year. I’m sure that many other tourists around the world will now consider Japan as a destination for a vacation. The devaluation of the Yen is working!

While I’m happy for my daughter (and those hoteliers in Tokyo) I’m frustrated by the enthusiasm that financial markets have demonstrated by the major devaluation of the Yen. To me, this is a zero sum game. The gains in Japan, are just losses everywhere else.

I see the big losers as Korea, China and the rest of SE Asia. America is going to get hit fairly hard as both tourism and trade react to the cheaper currency. Europe is so screwed up today the consequences of the Yen devaluation will be masked, but the German car exporters will get beat to pieces as the exchange rate adjustment flows through on car prices.  Places like Brazil will feel the consequences as well, liquidity out of Japan will leak into local capital markets, it will be the source of unwanted inflation.

A lot of my readers resent the fact that big money gets bigger because it is big. The Yen devaluation is a classic example. It’s my understanding that some folks have gotten spectacularly rich from the plunge in the Yen. (not just those who made it to the papers) The beauty of the Yen short trade is that there was very little risk. The government telegraphed its intentions perfectly. Damn near every speculator in the world was able to profit from what has happened. The gains are measured in the 100drs of billions of dollars. Once again, the central banks have made market players rich. The vast majority of the speculative currency gains will never get taxed. The rich and powerful just got richer and more powerful

Who will pay for the speculators gains? The Japanese citizens will be forced to kick in a huge chunk. The cost of everything that is imported into Japan is now 25%++ higher than a half year ago. The US economy will surely play a price. How much of a drag to US GDP is the Yen devaluation going to cause? I think the number starts with 1/2 percent.

China is going to get thumped. I don’t think China is just going to roll over and give Japan a free ride. Some retaliation is in the offing. “Things” between China and Japan have been very rocky over the past half-year; they are going to get worse. Japan has created an enemy with China, this will not end well.

In my years of watching FX, I’ve never seen a soft landing from a devaluation. I don’t think Japan in 2013 will be any different. Japan Inc. may be happy to see the 100/dollar exchange rate, but I doubt that the Bank of Japan can achieve equilibrium at this level. The risk is that the USDJPY overshoots (they always do). There is a very real possibility that things get out of control and a move to USDJPY 120 is in the cards. I see a near zero chance that the BOJ is going to step into the currency market and do reverse intervention to contain Yen the weakness. If enough speculators believe as I do, then we are in for a hell of a ride in the coming months.

Japan is desperately seeking to export its deflation – I think they will succeed. But when the deflationary consequences hit Japan’s trading partners, a global slowdown will be the result. Japan’s trash is being passed around the globe. I wonder how long the rest of the world is going to stand for it. Give it six months (or less) for the damage to be felt in the USA, and then the backlash will start. That, or China does something ugly. Either way, those who are singing praise for Japan and it’s effort to undermine its currency are going to be singing a different tune.

There is a perception that Japan’s monetary policies are directed inward. People like Bernanke are saying that any monetary stimulus is good stimulus, nothing bad can come of it. I don’t see it that way. I see Japan as a global aggressor, the country doesn’t give a damn about where the chips fall outside of its borders.


And here’s a different but complementary take from Daily Bell :

Is Japan’s Devaluation an Attack on China?
Japan stimulus will start currency war, say Chinese economists … Plan to buy bonds will open liquidity floodgates and spells doom for other nations, observers say … The Bank of Japan will double its monetary base to 270 trillion yen (HK$22.1 trillion) by March 2015. Many of China’s top economists are livid at what they view as an effective currency devaluation by Japan and are calling on the People’s Bank of China to retaliate by weakening the yuan to defend itself in what they see as a new currency war. – South China Morning Post

Dominant Social Theme: Japan is doing what it has to do.

Free-Market Analysis: In an article yesterday we suggested that the reason Japan was embarking on a massive attempt at Keynesian-style stimulation was to promote the efficacy of Keynesian economic “cures.”

But there is another possibility as well. Perhaps the idea is to start a currency war aimed at least in part at China.

Japan is a longtime ally of the US, which defeated it in World War II. It is certainly possible that Japan has allied itself with the US to serve Anglo-American interests in this regard.

This would tend to contradict a hypothesis we offered yesterday having to do with Japan’s monetary intentions. We suggested that the Keynesian (neo-Keynesian actually) recipe of printing debt-based paper currency was going to be declared a success in the West no matter what.

We suggested that this high-profile Keynesian approach was being implemented in Japan with the intention of declaring it a success no matter what. Japan, after all, is far away from Europe and the US. It is easy for a state-controlled media to massage statistics and economic performance so as to make the case for Keynesian efficacy.

And there is no doubt that printing money “works” when it comes to economic stimulation within certain parameters. Printing paper money and depositing in bank coffers provides banks and then the corporations they lend to with increased liquidity.

Often this liquidity finds its way into the stock market that is then used as a barometer to declare that the economy is “on the mend.”

But it is indeed possible to hypothesize that Japan’s current policy is intended to confront China and therefore is being used as a monetary “weapon of war.” Here’s more from the article:

ANZ Bank’s Liu Ligang see[s] Japan’s plan to double its monetary base within two years as “blackmail” and have criticized the Japanese central bank’s decision to open the liquidity floodgates to bump up the economy.

Liu said Japan’s unprecedented easing programme, aimed at ending more than two decades of deflation, was “a monetary blackmail” targeted at other export-driven Asian countries such as China and that the central bank should sell more yuan and buy the US dollar to push down the yuan.

He also called on authorities to guard against a fresh wave of hot money into China’s fragile financial markets, warning that Japan’s move would reignite the so-called carry trade, under which investors borrow in low-interest yen and invest in high- interest markets.

“The massive monetary stimulus by the Japanese central bank could spell doom for other nations in the region,” said Tsinghua’s Li, a former adviser to the People’s Bank of China.

“China could accelerate the freeing up of its capital account by boosting outbound investment in overseas equities markets, which could be an effective way of coping with the latest round of the global currency war.”

We can see from the above perspective that the Chinese are alarmed about the idea of a currency war because it affects their exports. China’s economy is in a delicate state right now and policymakers have depended on monetary stimulation to keep exports at a high level.

Not only that but US pleas for China to raise the yuan against the dollar have not swayed Chinese monetary policy at all. However, if the Japanese begin to print aggressively, the Chinese might have no choice but to retaliate by printing more yuan.

This would cheapen the yuan against the yen, and presumably also against the dollar. It is no wonder that Chinese economists – presumably at the behest of the party itself – are voicing displeasure over Japanese moves.

Perhaps, then, the Japanese policies have several objectives. One is to stimulate the economy (doubtful) and another to illustrate the efficacy of such state-implemented policies. Perhaps the third is to unbalance the Chinese monetary policy of keeping the yuan low against the dollar, thus encouraging Chinese exports.

Conclusion: Money should not be a political or industrial weapon. Unfortunately, in this era of central banking, it certainly is.


Some thoughts
From Krasting: “Japan is desperately seeking to export its deflation – I think they will succeed.” This perfectly sums up the purely economic part of the story. Now that the yen is down by 30% or so versus the dollar, euro, and yuan – just in time for earnings season – watch the results of big US and European exporters. If they’re weak, and especially if local stock markets begin to reflect this weakness, political pressure will build on the Fed and ECB to recover the advantage of a weak currency. The result: QE, instead of scaling back, will expand aggressively.

China is already mad at Japan over those islands in the China Sea, and now has a more tangible reason to lash out. How it will do this is yet to be seen, but none of the choices – stepped up military pressure, aggressive monetary ease, trade sanctions of some sort, cyber-attacks – are recipes for stable, sustainable growth.

And none of the above will fix anything. This year Japan exports deflation to its major trading partners, pushing them closer to the debt-collapse that their balance sheets say is imminent. Next year we send the deflation back, with interest, pushing Japan closer to the edge. This currency war ends, apparently, with one or two combatants imploding, though it’s not at all clear which will go first.

8 thoughts on "Welcome to the Currency War, Part 7: The Zero Sum Game"

  1. Japan is playing Russian Roulette with all six chambers loaded. Lowering the purchasing power of the Yen is nothing more than selling at lower prices across the board. Sure thwy export more products and they’ll get more nominal profits, but this money now buys less. In other words Japan is now poorer because they shipped more products out of the country without getting more income in real terms. Of course, the Keynsians will never understand that.

  2. What strikes me about both of these articles are the respective author’s implied assumptions about how things will play out. The fact that they lead to conundrums does not necessarily mean they are so indeterminate; the assumptions themselves may be wrong.

    In fact, those assumptions have already been challenged by the recent JPG price and yield action in just the past week or two. Conventional theory dictated that the prospect of aggressive bond buying by the BOJ next year would raise JGB prices now in anticipation of (i.e., “front running” of the BOJ) those purchases and thus lower JPB yields even lower. However, that has not happened. Instead JGB prices have dropped and yields risen. To my way of thinking that is the more rational response, but us financial world watchers haven’t seen such sanity in years so it’s a little suspicious. One explanation could be that since the BOJ cited the creation of inflation as its main goal, rather than something more complex like employment, that JGB holders simply jettisoned their low yielding bonds in expectations of higher inflation that they assumed the BOJ would ultimately create. Another, even more rational explanation, is that any currency that is expected to weaken over time (as the BOJ is vowing to do to the yen) should absolutely imply higher interest payments to any lender (e.g., a bond purchaser) to compensate the lender for receiving less valuable currency during the term of the loan and at maturity.

    But even all of that is based upon investors’ beliefs and expectations. Has anyone been paying attention to what’s been going on monetarily in the US? Why is everyone so sure that the BOJ will succeed in creating the 2% annual inflation it so desires? The first round of Japanese central bankers failed by doing what they thought would work, so why is everyone so confident that this group of central bankers will succeed? (And just at creating 2% inflation, never mind anything more beneficial and sustainable.) Is it really because of our modern world’s sound bite culture, that the “2-2-2” riff is just so persuasive (i.e., doubling the monetary base in two years equals 2 percent inflation!)? It’s almost embarrassing, even if some theoretical calculation avows it. Consensus opinion, circa Spring 2013, is that because Japan has been attempting to fill multiple multi-national “black holes” with quantitative easing for 20 years that hasn’t yet moved the needle, stepping things up a bit will surely do the trick. Why? Says who? Because this is Abe’s second chance?

    The US Fed has been trying to kick start the US economy since 2009, a mere 4 years so far. Ever since it began it’s own quantitative easing measures people have been fearful of a resurgence of price inflation. But the Fed claimed that QE would NOT create inflation. They never explained why not, but others postulated numerous reasons: “You can’t have inflation if unemployment is high,” and “QE is simply a way to recapitalize the banking system,” and “The Fed’s money is just piling up as reserves, it’s not entering the real economy through loans,” and “New money is simply balancing the loss in credit assets because of ‘deleveraging’,” and “A few trillion in new money is a small fraction of the total global money and credit supply. It’s negligible,” etc. The point is that those very same arguments apply to Japan too, the inventor of “quantitative easing”, and only more so. What fundamentally is the difference between funding government deficits to pay for infrastructure repairs from their storm and the living expenses of most people in the US? So, again, why is everyone so convinced that Japan will succeed in creating (foolishly) yen price inflation? Not that it won’t or can’t happen initially because of mass expectations, but longer term.

    The irony of all of this is that the only reason most countries are in these situations is because their governments did not allow the big profligate banks and corporations to go under as they should have according to free market capitalism. So until everyone realizes that they’re off the reservation almost anything can be made to appear normal, at least for a while, because the inmates are running the asylum.

  3. If the US cannot get China to “raise the yuan against the dollar.” a surrogate action to bring this about would not be at all surprising. Japan and the US are working in concert to bring about economic instability in China. China’s response may not be as predictable as one might be led to believe. Sun Tzu

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