Notes From Underground: The Yen Will Not Be the Sacrificial Lamb

And by the end of trading the YEN had reversed its initial weakness and wound up stronger–the 24-hour trading range was 79.20-78.25, with the settlement at 4:00 p.m. CST, 78.37. It seems that the market will not allow the BOJ (Bank of Japan) to do less than the ECB or the FED. BOJ Governor Shirakawa raised the asset purchase program to 80 trillion YEN from 70 trillion and removed its 0.1% bidding floor for Japanese Bonds (JGB). It is now possible that the BANK will go to negative bids on its JGB buying program so the move was aggressive for what has been a very conservative policy-oriented institution. Even Japanese FINANCE MINISTER Jun Azumi said, “The BOJ took more action than we anticipated.” And again although the YEN weakened on the initial news, by day’s end it reversed and closed strong. Mama, don’t let your children grow up to be currency traders.

Continued yen strength will force the BOJ/MOF to become even more aggressive now that the FED and ECB have gone to LUDICROUS SPEED in the move to provide continued liquidity to their markets. Some analysts think that the BOJ/MOF won’t get aggressive on weakening the yen until after the U.S. elections. Maybe, but the Japanese are now awakening to the fact that with the world economy slowing and a “fiscal cliff” in the U.S. looming this is not the 1990s. In the previous period of Japanese deflation and a strong yen, the rise of the Asian miracle and strong U.S. growth allowed the Japanese economy to muddle along … not all decades are created equal.

***If an economic theory fails and economists don’t acknowledge the outcome, is the theory still wrong? The question arises due to the move by the BOJ to aid liquidity in the face of dynamic moves by the world’s two other central banks. If all this QE in place and overt actions to stem currency strength–A RACE TO THE BOTTOM–if economic growth and the GRAVE unemployment situation fails to improve, will trade sanctions be next in a bow to political pressure? Will a trade war bail out the QE theorists by providing rationale for the failure of massive doses of liquidity to gain economic traction?

In an effort to combat the extended ease and targeting of nominal GDP going to lead to the beggar thy neighbor policies of the 1930s? The Michael Woodfords of the world can say, “We weren’t wrong, it was merely that politics got in the way.” There are now many variables in motion so market volatility is going to increase and all previous correlations will be challenged. We’re going into the forest of economic theory to hear if any theories are falling.

***Yesterday, Richmond Fed President Lacker delivered a speech in New York in which he provided the rationale for his no vote at the FOMC meeting last week. Lacker clearly stated, “Channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve.” He cited a March 23, 2009 agreement between the Fed and The U.S. Treasury: “Government decisions to influence the allocation of credit are the province of fiscal authorities.” In Lacker’s view–and I concur–the Fed is buying MBS to “influence the allocation” of funds into the housing sector.

Lacker raises a very serious issue and blowing the horn on the Fed’s involvement in the fiscal arena. This issue being presented by a Fed board member will give the anti-QE crowd a great deal of ammunition. The FED’s MBS buying is due to the huge imbalance the FED has caused in the repo market by owning much of the good collateral. If critics and Congress continue down the path of accusing the FED of trespassing into the realm of fiscal policy, it will result in the Fed changing course and having to become more creative in its efforts to target NGDP. Otherwise it will have to ask for a third mandate.

***Tomorrow’s Financial Times ,the analysis piece is on Mexico and its growing manufacturing sector: “Analysis–China’s Unlikely Challenge.” Regular readers of NFU are aware that I have a bullish disposition on Mexico that is predicated on a change in the 1938 Constitution, allowing for foreign investment into Mexico’s energy sector. Presently Pemex has a total lock on all of the energy exploration and products derived from petroleum. Many candidates have pushed to allow foreign energy companies into Mexico but have been rebuffed by the established law and power of Pemex. However, Mexico is in need of advanced technology in order to drill for tougher to find oil and it is expensive. As the Cantrell oil field continues to decrease production, Mexico will have to search for outside funds for Pemex is short capital because of the huge amount of funds it returns to the Mexican Treasury. A large part of the government budget is funded from the state-owned energy sector. The second reason I have been bullish is because of the depreciation of the MEXICAN PESO during the last 18 years.

As the Mexican currency depreciated against all of the world’s trade currencies, the Mexican industrial sector was quietly gaining a trade weighted advantage to go with its geographical advantage to the world’s largest importer, the U.S. The key date in comparing Mexico to China is January 1, 1994. Two important events happened on that day: 1. NAFTA went into effect; and 2. China devalued the YUAN by 50%–happenstance, only if you are naive. The Chinese Yuan was devalued from 5.8 to the DOLLAR to 8.7. The result was that China was able to upset the NAFTA outcome to help Mexican manufacturing by utilizing Mexico’s cheap and ample labor pool (think MAQUILADORAS, the factories that sit on the U.S./Mexico border). The factories that were supposed to be providing products for the U.S. market was left empty as U.S. corporations sent capital investment to China to access phenomenally cheap labor and a devalued currency. Even the Asian tigers succumbed to the power of the Chinese devaluation and by 1997 the Asian miracle was becoming an illusion and the two-year period of collapse became the Asian contagion.

The FT piece brings up an interesting point: “A decade ago Mexican wages were 391% HIGHER than those of China. Today, they are just 29% more.” The article brings up many issues that are aiding Mexico such as its role as a local hub and the fact that Mexico has established free trade agreements with 44 countries. It also notes that a decade ago, 90% of its exports went to the U.S. but “today Mexico exports more manufactured products than the rest of Latin America put together.” Further, it notes that FIAT is even exporting cars from Mexico to China. Nowhere does the article discuss the competitive advantage of the PESO but I am blowing the horn. In 1994 the peso was 3.11 to the U.S. DOLLAR and because of continued depreciation and a free float the MP is trading at 12.8 to the dollar.

Yes, up until 1998 Mexico was running 20% inflation rates but since 2000 rates have consistently been about 4%. More significantly, the PESO has had a huge devaluation against the Chinese yuan. It may be time for some of the global multinationals to begin thinking about Mexico–time to buy some of those mothballed MAQUILADORAS. The PESO may not rally in this present environment of risk on/risk off, but certainly something to put on our radar screen for the longer period.

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8 Responses to “Notes From Underground: The Yen Will Not Be the Sacrificial Lamb”

  1. Michael Greenberg Says:

    One thing about Mexico to keep in mind is the rampart crime, particularly the kidnappings that are focused on wealthy families. These wealthy and productive families are buying second homes in the U.S. and, more importantly, are sending their money here. And this cross border flood of money is having an influence on the exchange rate. Just keep it in mind.

  2. Norbert Beckstrom Says:

    This was an excellent “Notes.” Particularly the work on Mexico.


  3. yra harris Says:

    Michael–no question about that but the flow of international money is search of higher returns built on “cheap labor” has dwarfed even the lure of drugs—building a middle class allows for the far greater distribution of wealth then the DRUG CARTEL–remember the U.S. had robber barons and the wild west was exactly that.

  4. Dustin L. Says:

    Yra- Will the MOF get busy selling to help change the perception of a rally in the Yen after the BOJ’s easing? I suspect they might do this as early as today. It would take less artillery now rather than later when the longs become more committed and confident. As always, the charts will clue us in.

    Great piece BTW!

  5. yra Says:

    dustin–thanks .As tor the MOF–it is a riddle mystery enigma to me .But as Churchill used these words to define Russia it certainly applies to how the MOF behaves and thinks.As Churchill opined;the key to finding out is figuring out their self-interest which the Japanese politicians seem unable to do.Some think that the Japanese do not want to piss off the U.S. monetary authorities by putting undue downward pressure onthe YEN–especially as tensions with China are on the rise.As you say –watch the charts–the 200 day m.a. on Dollar/yen is 79.32 or so—let your numbers be your guide

  6. Dustin L. Says:

    Yra- Well said sir. The US monetary authorities would hardly have scope for being too upset given the levels of the Yen, which is not to say that they wouldn’t be. But, the elevated Yen might provide some room for the MOF to work within. And, Japan can hardly afford a rising Yen and a slowing economy in the face of tensions with China. I have a hard time seeing China and Japan going to war with such a large economic mutual interest but, the history and bad blood between the two runs deep, and we humans really are more driven by passion than by reason. I will heed your advice and let my numbers guide me.

  7. Mario Says:

    The tortoise is winning the race when you look at Mexico, Indonesia,and Canada these days. The rabbit was winning the race via China, Australia, Brazil, US, India……Next quarter will bring out the steam in these sails more with food prices but luckily for the glich oil is down a tad. Most of the tortoise countries have currencies which has devalued with less synthetic policies, as the whole worlds currencies are worth much less with monetary stimulus and policies……Where to watch coming into OCtober and next year?

  8. yra Says:

    Mario–you ask the ultimate question which we will follow and your analogy of the tortoise and the hare seems about right.Now if Mexico could begin to respect the rule of law and begin to rein in corruption it could be the decades big story

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