Warning Shot – Japan Warns On Rapid Yen Rise

| November 12, 2007

1000 Yen Note.gif

Once again we are looking at a strange tidbit of information from a far away corner of the world, and how it can have a substantial impact on the US and world economy.

From the Financial Times of London:

Fukuda warns on rapid rise in yen

The yen is appreciating “too fast” and speculators need to “be careful”, Yasuo Fukuda, Japan’s prime minister, warned in an interview with the Financial Times on Monday.

As the yen moved to an 18-month high of Y109.13 to the US dollar on Monday night, Mr Fukuda said: “In the short term, yen appreciation would certainly be a problem. Any kind of sudden change in exchange rates would not be desirable.”

His remarks came shortly after Nobutaka Machimura, chief cabinet secretary, surprised some market participants by appearing to back the yen’s appreciation. “It is wrong to think that Japan should object to the yen’s appreciation. In fact, I think a high yen is basically good for Japan.”

Those comments helped push the yen through Y110 to the dollar for the first time since May 2006

I am certain you are convinced that my nascent sophotech / knowledge assembler software has thrown a bolt big time. Lets explain why this is possibly a very worrisome report.

Japan has been in recession (some would say depression) since it’s housing market and debt systems blew up in the 1990’s. During that time the price of real estate had climbed so high that families were signing up for more than one generation just to afford a home. Of course that was unsustainable, and crumbled in a colossal wreck. Since then Japan’s economy has been on the ropes, and the government there has been trying everything to get the economy healthy. This included slashing interest rates to pretty much zero, and devaluing the Yen to ridiculous levels. In spite of all this it really has not fixed the Yen or Japan’s economy.

What it did fuel was speculation in currencies. Specifically what came to be know as the “Yen Carry Trade” – an obscure term that will, in the end of the day, have broad and massive impact on just about everything. Let me explain.

Lets say you want to create a “deal”, but to do this deal you need a lot of cash. You could get it by borrowing it from some US or European investment firm, or you could borrow it in Yen in Japan. Seeing as the interest rate is near zero, and the Yen is cheap, you can think of this as “free money”, as long as you assume the Yen will stay low for the life time of your “deal”.

So you borrow a few billion Yen, and you have your deal. Now a few years on the Yen starts to appreciate. Everyone who was playing this “carry trade” is starting to feel a lot of heat. For each 1000 Yen they borrowed thinking they would have to pay back 1000 Yen later, they have to pay back 1100 Yen today, and the trend is upward. Suddenly that free money is not so free. Worse yet, maybe you took that cash and did some “Equity Re-Postitioning” and bought US stocks with it. Think of it as an adjustable rate loan to the tune of a few $100 Million.

Normal people did not take these out, big companies like Citibank, Goldman and Merill were using this as one of the primary conduits to power up deals that at the end of the day will look very foolish.

As if the pillars of our economy were not under enough stress already, an appreciating Yen is possible the biggest threat of all, because the leverage they used was so huge. Leverage means they took 10 Million Yen and borrowed 200 Million Yen with it as collateral. So the amount that they are responsible to repay could move very quickly higher.

Worst of all it could force them to liquidate assets. Normal people raise money this way, but for these large investment firms many of the things they would have to sell are not nearly as much as they have been claiming on their balance sheets and federal reports. Being forced to sell them, even a few of them, would cause all of them – at some estimates over $1 Trillion – to be re-priced at a market rate.

Everyone in the financial world, government and private, are fighting tooth and nail to prevent this from happening because it might just cause the collapse of some segments of the economy. This is why they are creating the Super Conduit, to hide all of this debt. This is what has the Federal Reserve scared, as well it should.

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Category: Credit Backlash, Economics, Main, Recession Watch

About the Author ()

Bruce Henderson is a former Marine who focuses custom data mining and visualization technologies on the economy and other disasters.

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