Notes From Underground

During the weekend BOJ Governor Shirakawa delivered a speech in which he stated that the BOJ is “ready to take appropriate action if needed” to deal with the strength of the YEN. It seems that the Japanese government has been getting more heat from the corporate sector because of the YEN’s relative strength and the damage it is doing to the major exporters. Shirakawa offered caution on how the “appropriate actions would proceed as the BOJ is prohibited from “monetizing debt”  and it also does not want to risk raising bond yields from fear of inflation.

BOJ seems to have a self-imposed cap on government bond buying so as to avoid debt monetization. Shirakawa alluded to the concept that the BOJ could not buy an amount bigger than the cash in circulation. He didn’t say that it was illegal restraint or just a precautionary stance. The BOJ is on the HORNS OF A DILEMMA as it risks creating inflation that would badly undermine the vast majority of domestic Japanese investors. It is important to remember that 97 percent of all outstanding JGBs are owned by the Japanese themselves–unlike the holdings of U.S. treasuries and MBSs. No wonder the Chinese are buying Japanese debt. It would be political suicide for the MOF to push too aggressively on the monetary creation issue for the huge impact it would have on retiring Japanese savers. Shirakawa and the bank, though, appear nervous that politicans such as the defeated OZAWA will make some move to amend the Bank of Japan law, which guarantees its independence. This is a very serious dilemma for the Japanese polity and we will watch closely. Ever since the initial intervention of September 15,the DOLLAR/YEN has settled down but the EURO/YEN has rallied from 108 to close out last week at almost 114. This is the best effect the Japanese could have gotten.

After all the glad handing between Wen Jiabao and Obama, China this week announced that it was levying anti-dumping duties on the import of U.S. chicken products. It has accused the U.S. poultry  industry of dumping chicken broiler parts, which has caused damage to its domestic industry. China says it will palce import surcharges of 50 to 105 percent. In the mainstay of world trade, this is no big deal–ok chicken shit–but it sends a message. Schumer and others want to place a tariff on the Chinese for currency manipulation, but the Chinese know that rural, agrarian states in the U.S. Senate and these states have a great deal to lose in a trade war with the U.S. American farmers are doing phenomenally as they export massive amounts of product to the Chinese. Many traders have been blindsided this summer by the continuing strength in ag markets, even as the U.S. farmers bring in record crops. Latin America also had large crops last year so even with drought in Russia and Ukraine, crop prices were and have held up very well. Even Caterpillar and John Deere have been in opposition to the Schumer initiatives. The Chinese have put the senate on notice that the tariff game is much more complicated than the simplistic language of populism.

The most interesting article over the weekend was the front page WSJ piece about the super-secret committee of European heavyweights that met to make sure the entire EU project didn’t implode. The acrimony between Sarkozy and Merkel was very real and we would suggest that the wounds will take long to heal. Sarkozy was doing everything he could to gain the upper hand on the bailout of the PIIGS and it was reported he tried to bring a television crew to one of the meetings as to embarrass Merkel.

As the story unfolded, it was a real possibility that the EU could have blown apart. As we blogged about a month ago, the idea of Sarkozy heading the G-20 beginning in November 2010 needs constant surveillance as a politically wounded Sarkozy is capable of great mischievous. The stresses in the foundation of Europe are far from over as the WSJ poignantly exposes. Yes, the EURO has rallied more than 10 percent since the height of this summer’s tensions. It probably is the surest sign of how weak the underlying fundamentals are for the U.S. DOLLAR. The more that is revealed about the fragility of the economies of the developed world, the more we realize how difficult the trading environment is and will continue to be. Keep your technicals up and be ready for violent swings as the global political economy reacts to sudden changes wrought by weak economic fundamentals. Throw in the impending trade friction and the surprises can come from all corners of the world. This is not the environment to be playing CHICKEN.