Is the rally in the yen really a “currency war”? And has China had enough of the yen?

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“Fallacies do not cease to be fallacies because they become fashions.”

                                                 G. K. Chesterton

Commentary & Analysis

Is the rally in the yen really a “currency war”? And has China had enough of the yen?

Despite whether it matters or not in a world characterized by flagging aggregate demand, the players are still keen on keeping their currencies suppressed. Modern day self-appointed experts seem to call every move in a currency a “currency war.”  Of course it is rarely a true “Currency War” in the hyperbolic manner these modern day scare mongers wish to imply.  Why do I say that?  Because currencies float freely for the most part (except for those which are pegged); that means they are driven by supply and demand from the market.  And market is now much more powerful than any central bank.  A free-floating currency cannot be unilateral revalued or devalued.  There are usually real fundamental reasons for a move in a currency (often not seen without the gift of hindsight); it is not always about this over-used notion of a “currency war.” 

The most recent example I am sure you have all read about is Japan.  They of course are “warring” against the world when it comes to their currency; it is said.  But let us see for a moment if we can let an important fact get in the way of the “currency war” theory:

The Japanese yen was trading at 125 against the US dollar BEFORE the credit crunch.  It rallied, i.e. USD/JPY fell, all the way back to 75.55 on October 31, 2011. 

But as the yen started appreciating sharply against all the major currencies, shouts of “currency war” didn’t fill the air as Japan’s was taking on the currency brunt of global rebalancing—maybe it’s just me.

Even now, despite the big rally in the US dollar against the Japanese yen, the pair has not yet made a full round-trip since the beginning of the credit crunch.  Yet, there are fundamental reasons why the yen has weakened—supply of yen seems to be increasing faster, or at least that is the sentiment in the market, and the BOJ says it will do more if inflation doesn’t remain supported. 

Though I am not sure how much risk is already is embedded in the price of the yen, but as you know there are growing concerns Japan will not be able to deal with their debt problem if Abenomics fails. 

I remember reading something from cycle expert Martin Armstrong a few years back; then he was suggesting a possible sovereign debt crisis in Japan in 2015 (I am not sure if that is still one of his views).  But even if default risk on Japanese debt is rising, we have to keep in mind the Japanese yen is a very perverse currency and it can trip up logical one-way thinking. 

What I mean is this: For many years Japan had a zero interest rate policy while other central banks were normalized; yet the yen rallied sharply at times during those years (thus goes the theory low rates always hurt a currency).  This seeming perverse price action in the yen likely represented repatriation flow back into Japan by key institutions, i.e. more risk domestically in Japan tends to pull money home no matter the yield.  So, going forward, if Abenomics fails the question will be this: Will the power of international investors running away from Japan on risk concerns overpower the money flowing back to Japan on the same concerns?  I do not know the answer. 

That being said, and given the relative positioning economically of the US, the sharp decline in the yen seems to make some logical sense.  But, what if you are export dependent and you don’t have a free-floating currency?  And your currency has appreciated sharply against one of your close competitors vying for the same flagging global demand because you have pegged to a relatively strong currency?  Well, given you control the peg (like some secret society controls its membership) you have a bit more power to act. 

And I think China is starting to act as signaled by the recent rate cut last Friday; and the reason it will likely represent the first cut in a campaign is because the Chinese yuan has rallied sharply against the Japanese yen.  I think China has had enough…

  …so the trade here is short CNY and long JPY…unfortunately punters like us can’t really access this trade given the yuan is not available for the most part to retail traders…this rally in Chinese yuan to the Japanese yen is looking a bit parabolic.  [It may also signal it may be time for the yen to take a rest against the pack, not just the yuan.]

So China will make it clear lower interest rates justify a weaker currency.  And it will likely make sure its crawling peg crawls in the right direction against Mr. Greenback.  But China has to be a bit careful here; because if the yuan depreciates too much against the US dollar, in China’s efforts to counter a weak Japanese yen, guess what—everyone in the US Congress will be yelling “Currency War.”  And sadly or not, hyperbole on this topic flowing from Congress, especially at time when globalization itself is in trouble, is something we need to listen for very closely. 

Thank you. 

Jack Crooks

President, Black Swan Capital ,