Yen Should Reverse Its '98 Rebound As Japan's Fundamentals Catch Up With It
By Peter C. Du Bois
Currency fears rattled overseas bourses last week. Even though Brazil's congress approved measures that could speed promised fiscal reforms, the real weakened (to 1.72/$ Friday) amid worries that inflation will rise rapidly.
In turn, Brazilian woes fueled spurious rumors that China would devalue the yuan on Friday. It didn't. China again said it won't take this step in 1999. We believe them. It just doesn't make sense.
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As regular readers of this column are aware, before a dollar-based investor buys any foreign stock, perhaps the most important decision to be made is the outlook for its home currency. If that unit rises against the greenback, potential gains in dollars could be enhanced. If the foreign currency falls, gains in dollars would be cut or losses exacerbated.
This leads us to the yen, which has strengthened markedly in recent months. For anyone weighing the purchase of Japanese shares, our unscientific survey of the yen's outlook found one bull and three bears.
For four reasons, Michael Naldrett, a Tokyo-based economist for Dresdner Kleinwort Benson, believes that "a sustained trend of yen appreciation is now in place." In his view, within 18 months the yen could hit record levels against the dollar, topping the 80/$1 peak in 1995.
The yen closed Friday in Tokyo at 113.70, against 113.46 on January 14.
First, he notes that over the past 15 or so years, Japan's current account "apparently has been a principal driving factor behind the yen's gyrations." As measured by the Bank of England's trade-weighted index, Tokyo's current account "has proved a reliable 18-month leading indicator." One possible explanation for this lag "involves trend-following capital flows." In any event, past BOE data suggest that the yen looks set to rally "for at least another 18 months."
Second, since 1988, again measured by BOE data, there's a close correlation between the Dow Jones Industrials and the dollar. In Naldrett's view, the future for the dollar "looks precarious." Seen from Japan, "the U.S. seems to be as much of a bubble economy as Japan was in the late 'Eighties." As he knows from Japanese experience, major bubbles end badly. Should the U.S. stock market suffer a meltdown, "a dollar disintegration would go hand in glove." In this event, "it would be quite conceivable" for the dollar to break below its 1995 low against the yen.
Third, since the late 'Eighties, the rate of growth of the money supply in Japan relative to that in the U.S. "has proved a reliable 18-month predictor" of the yen/dollar exchange rate. This indicator, Naldrett says, now calls for a stronger yen.
His fourth point is esoteric and involves the higher mathematics of chaos theory. Briefly, "there exists some evidence that exchange rates are fractal time series. If so, they may be expected to exhibit cyclical behavior." Frankly, we had to seek a definition of fractal. According to the Oxford dictionary, it's "a mathematically conceived curve such that any small part of it enlarged has the same statistical character as the original."
So be it. Moving right along, Naldrett argues that "focusing on rates of change rather than levels," the yen has just entered a phase of appreciation against the dollar. Take a wild guess where he sees the yen headed. |
