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Strategies & Market Trends : John Pitera's Market Laboratory

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To: Hawkmoon who wrote (5555)	2/11/2002 8:08:51 AM
From: Henry Volquardsen	Read Replies (2) of 33421

Good mornin' Hawk.... and the rest of the thread, Sure there are devaluation examples. But there is a difference between an emerging currency and a global reserve currency. Not to get into semantics but the issue is not lax capital controls but the nature of the capital controls. The currencies you mentioned were/are all highly regulated. This gives the government a measure of control that allows them to dictate devaluations. But even that is problematic as seen by the black market in Argentina trying to push lower. Japan is a different story. It is a reserve currency and freely traded. The Japanese don't have a mechanism at the moment to just say they wish to devalue. And it would be politically infeasible to put such a mechanism in place. But that doesn't mean Japan won't try to devalue. As I said earlier that is by default their only viable alternative. My point is merely that they will need to do so by convincing the market to take it lower. They will need to take actions that will result in market led devaluation. And that is easier said than done. It is easy for us to look at the Japanese economy and say it requires a devaluation but there are obstacles. First off Japan is already running huge trade surpluses. This is creating a natural demand for yen that would tend to strengthen it. Generally a currency looking to do so is doing so in the face of large trade deficits. Second the large savings pool and external assets provide a counterweight to devaluing the yen. The deflationary pressures in Japan have prompted significant, at times, repatriation of overseas assets. It is worth remembering that the outlook was almost as dire in the mid 90s yet the yen strengthened to the low 80s on repatriations. Which leads to the real point. Japan doesn't need a devaluation. The trade and current accounts make it clear that currency values are not the issue. We have only settled on devaluation as a response because we believe it is the only viable alternative. The real solution is actually something else. Japan needs to write off the mass of bad asset as a start. But when you follow that trail you get to the core problem. At heart it is the huge national debt that will continue to strangle Japan. A debt that has grown in response to ineffective attempts to prop up the economy and engage in round after round of poorly designed pork barrel stimulus packages. That is what needs to be dealt with. And since they have little chance of growing out of it the solution is to repudiate the debt. The problem is that repudiation is politically impossible. So we fall back on trying to finesse the issue by repudiating the debt via currency debasement. But currency debasement has its own problem. First the main way to do that is to ignite domestic inflation. They have been trying that. It is very tough to ignite inflation in a deflationary environment. To devalue the currency when there is no inflation will only balloon the trade surplus. That would help the Japanese earn their way out but that would be a very tough sell internationally. After the experience of the 60s onward it will be very tough to convince the world they need to tolerate huge Japanese surpluses to earn their way out. So it is easy to say Japan needs to devalue but in practice it is not as straight forward as the government just doing it. Fwiw I absolutely agree with the notion that a massive yen devaluation would increase pressure on the US and global economies. Technically the Japanese trade surplus will act as a tax on the international economy. But as I said above it is easier said than done. Btw your argument that Japanese assets would be far more attractive and prompt a massive capital outflow argues against your yen devaluations scenario. If that were to happen it would reverse the yen weakness and increase US competitiveness thereby stimulating the economy. The Japanese situation is pretty unique. I've been watching it and trading it for a very long time. I was having a long conversation with a good friend about a month ago where we discussed our experience with the yen. It occurred to me that we have all been standing around for close to 10 years saying that a currency and bond market collapse is inevitable. Yet it hasn't happened yet. So we discussed the micro issues, such as the ones mentioned above, and it has started me to thinking about whether a massive devaluation is really possible. Deflation, surpluses and politics argue against it. And what have we seen since then? Half measures and compromises that continue to drag the situation on without a definite resolution. I'm beginning to wonder if the Japanese can't keep up this for some time. It is a dire outlook for Japan but it is a survivable outlook for the global economy. No one is factoring in Japanese growth so as long as they don't collapse the world moves on as other players, such as China, grow into greater factors as growth engines. Everyone is expecting a Japanese implosion. What if we get the economic equivalent of the Ottoman Empire and Japan just becomes the sick man of Asia and just continues to drift in a torpor while the rest of the region grows passed them? Henry

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