From Veneroso about the Yen. Looks like his thoughts on the Rubin modus operandi are identical to mine-that he wants Japan to cry Uncle. This guy Rubin may have been a great investment banker but if he doesnt get his act together shortly, he may go down in history as an utter failure. His iron will can not be imposed upon all of global society even though he personally (and his Wall Street Cronies) might find this desirable. This man needs to throttle back on his incredible hubris-a characteristic which is highly desireable for success on Wall Street but dangerous in global politics. Imagine the Chinese opinion of a guy like him:
Veneroso Associates
June 15,1998 Frank A. J. Veneroso
The Yen
ú Despite Rubin's Comments, There Is A Good Chance of Intervention
The following note adopts the premise that a further fall in the yen, a Chinese devaluation, and a new round of currency devaluations in the emerging world threaten a yet deeper decline in the emerging country economies and thereby threaten global deflation. This view, widespread in today's markets, was expressed publicly last Thursday by Deputy Prime Minister Supachai Panitchpakdi of Thailand.
HONG KONG, June 11 (Reuters) - Thailand's Deputy Prime Minister Supachai Panitchpakdi said on Thursday excessive falls in the Japanese yen might trigger a second crisis in Asia which would develop into a global depression. "Competitive currency devaluation will spell the second crisis and that might be initiated if the yen drops below a certain level. That would drive all the funds away from Asia. It would pull the whole world into it. It would be like a black hole," he said. "Asia's second crisis.would become the world's first financial crisis. And so recession in Asia could be turned into a worldwide depression," he told the seminar.
This note adopts this premise, not because it is sound economics, but because it is so completely the perception of the marketplace that it is somehow self fulfilling. In theory, currency depreciation throughout Asia should help these economies through trade. It is the industrial sectors of the US and Europe that should suffer. At today's exchange rates---let alone after a further devaluation---the cost of production is so much lower in Asia that capital should be flowing to this region, not from it. Why then, the perception as well as the actual process whereby a further yen devaluation will generate global deflation and depression?
The answer lies in the behavior of today's mobile global capital flows. No effort is made to discern long run prospective returns by today's markets. If these markets did focus on such long run returns, issues like country competitiveness would come to the fore. Rather, today's markets chase trends, regardless of relative prices.
Look at the Asian stock markets. They are making eleven year lows in domestic nominal currency terms. Over the last two decades these countries have experienced the greatest sustained economic expansion since the onset of the industrial revolution. Their real economies have expanded by twofold or more over these eleven years. Their economies in nominal terms have increased by three or fourfold over this period. These Asian markets sold at low valuations eleven years ago. How can they sell today below the levels of eleven years ago? Imagine if the US stock market fell to below the level that prevailed when its nominal GDP was 1/3 or 1/4 current levels. Because the US economy is a slow grower, that would take us back to the 1970's. The Dow would have to fall to 700 to pierce on the downside those prior historical lows.
Something like this has happened in emerging Asia. The values must be extraordinary. If Asia devalued yet more, its manufacturing sector would become yet more competitive. Yet, we assume, because of the mad way today's world works, that Supachai is correct: that a further round of devaluations would accelerate the outflow of mobile international capital, aggravate the regional financial crisis, deepen the regional depression, and threaten global economic activity. With this somewhat mad starting point, we make the following comments...
The Yen
Despite Rubin's Comments, There Is A Good Chance of Intervention
Given the trends in inflation and in productivity in tradeables in the US and Japan since the last time we were at 145 yen, Japanese competitiveness should be far greater today than it was then. The Japanese have further increased their competitiveness by moving the labor intensive component of their output to the emerging Asian countries which have now drastically devalued against the dollar. Two years ago Japanese firms estimated they were competitive at 106 yen/dollar. Today Japanese competitiveness must be off the charts.
When asked about the growing US current account deficit, Greenspan recently said that is Rubin's turf, everyone wants to buy dollars now, but in the long run the financing of a wider US current account deficit cannot be sustained. The Fed probably understands that the yen has fallen too far.
From a long run perspective, trade theory says 145 yen is not sustainable. But today's markets care only about momentum, not trade fundamentals. Policy makers usually care about such fundamentals. The domestic industries they serve usually care about such fundamentals. Rubin is unusual in that he has relatively little concern about such trade fundamentals. His focus is to keep capital flowing into US stock and bond markets, to impose US style market regimes on other countries, and to increase access by US firms to foreign assets and markets.
Rubin wants reforms in Japan that favor US business but that tend to deflate domestic demand in the short run. Rubin wants more fiscal stimulus in Japan where public sector debt and deficits are already very high. The Japanese understandably are reluctant to aggravate short run economic weakness and long run fiscal and public debt problems. They remember that US pressure in the 1980's for Japan to stimulate domestic demand contributed to the "bubble" economy, the legacy of which is at the heart of Japan's current problems. This muddies the outlook for G-7 intervention.
Long run, there is only one solution for Japan: the government must remove the bad loans from the banks and increase the monetary base enough to generate a yen inflation . It is not an issue of if these two things will happen; it is a matter of when. Japan is moving tentatively toward both. If it continues to move tentatively the crisis will deepen.
If it moves decisively, rapid monetary base growth will tend to weaken the yen (as it is doing already). Does that mean the yen must devalue further if Japan accelerates monetary base growth? No, since yen weakness now is driven above all by perceptions that the Japanese economy will remain in decline forever. Getting the banks into a position to function again will be the turning point in dynamic fundamentals. When it becomes apparent that the credit-dependent Japanese economy will be able to grow again in a sustainable fashion, yen pessimism will fade. Then the yen will be a multi-year buy independent of G-7 intervention.
What about the short run? The G-7 could manage the dollar down if it wanted. It could "talk" the dollar down by focusing repeatedly on long term trade competitiveness which today's specualtor's raders are currently ignoring. If Big Brother bleats sufficiently above a woeful US trade outlook, it will change the fads and fashions that drive today's speculative capital flows. The G-7 could also engage in coordinated intervention. The markets assume coordinated intervention cannot work, but it has worked in the past whenever exchange rates have moved too far from long run equilibria. The US has a large and widening current account deficit. Ever greater capital flows are needed to keep the dollar where it is. Only an abatement, not a cessation, of today's perception driven speculative short term capital flows are needed to restore stability to the currency markets.
Managing the dollar down would bring currency parities more in line with long term trade fundamentals. It would help stop the irrational speculative capital outflows from Asia and the emerging world that are at the root of the financial crisis there. Under current chaotic conditions, both are desirable objectives. Unfortunately, it appears that Rubin's political wish list for Japan impedes a move toward coordinated intervention.
Everyone fears a Chinese devaluation could deepen the global currency crisis. On Monday and Friday of last week the Chinese stated that they would hold the line on the rimimbi but hinted that they might have to devalue. When you are defending a currency,. you never hint that you might devalue. The Chinese have. We must interpret this as a threat to the G-7.
Clinton is going to China in a week and a half. It appears that the Chinese are applying pressure to the G-7 to stabilize the yen.. The speculative community is massively short the yen. They are convinced that Japan can do nothing before the Japanese elections in late July so there is no near term risk. They have been emboldened by the failure of Japan's intervention at 135 yen and by Rubin's statement that intervention won't work until Japan gets its house in order. Using charts and similar technical tools, today's speculators project yen/dollar targets (170,240, etc.) that make absolutely no sense from the perspective of trade theory.
The Chinese are threatening that, if the yen keeps falling, they may devalue. They will make clear to Clinton the US must push for currency stability in the region. Such political considerations may move the US to agree to massive coordinated intervention to reverse the decline in the yen, despite Rubin's desire to play chicken with the Japanese to get his political wish list. Because the speculators are so short and so complacent before the July elections, it might work. It would work if the Japanese moved to change perceptions about the outlook for Japanese growth, possibly by agreeing to strong measures after the elections to reduce bad loans in the banking system and to cut taxes on consumer incomes. " |
