Rising Sun Rises On Y2K, Yen Goes Home, Part Deux

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Lets play connect the dots shall we. When last we left off, the Japanese government was facing a liquidity crisis with two many JGB's comming to market, and bunch of buyers who were scared off thei ass regarding JGB end of year liquidity. Everyone was afraid that this auction would be a disaster. I posited that the Govt of Jap. would step in and NO MATTER WHAT this auction would go smoothly. Guess what? It did. 2.93 bidders per bond according to one report. However,traders did report that it wasn't stellar and that the only reason that it came off at all was the strong rumor that the govt would be taking extraordinary measures at year end to make this thing OK for all. Fast forward to the currency markets where the dollar is experiencing a record slide. I mean this thing can't eve SEE the floor right now. The herd generally believed that the Govt. of Jap. would step in once it got below say 110 to 113. But guess what, those stops came and went just like all those boys yucking it up out at Jackson Hole with big Al over the weekend. In his market wrap segment today, Bill Fleckenstein had an excellent section on the Yen/Dollar situation. Here it is for fair use research and educational purposes only:

SNIP August 31, 1999 Market Rap with Bill Fleckenstein www.stocksite.com (go to this site and learn something) The big news last night was the fact that the dollar-yen broke pretty hard through the 1.10 level. It traded down to just about 1.09 even, nearly a 2 percent move. Asian markets didn't like it, with Japan leading the decline, down about 2 3/4 percent. This is a big deal, and a story on one of Japanese news services stated that Japan was prepared to see it go to 1.05 and lower.

Colin's dollar-yen commentary... My friend Colin Negrych had some comments specifically about the dollar and the yen that I'd like to share with you. I think they are pretty on the mark and worth reading.

"People keep telling me the Treasury...the G-3...somebody is just going to have to do something to prevent the dollar and U.S. asset prices from falling...to avoid a global recession. Complete crap. (1) The dollar was abandoned by the U.S. last summer and global investors now see this. (2) The best way to avoid a global recession or lessen its severity...is to deflate the U.S. asset bubble...in particular by raising U.S. rates. The more the Fed raises rates...the more "monetary capacity" it will have to offset the balance sheet damage which will result from the U.S. stock market "normalizing"...and by raising rates N-O-W the Fed can "cap" the balance sheet damage at the current embedded... inevitable...level...and obtain maximum wherewithal to counter the "economic" consequences it will produce.

"Folks still do N-O-T understand the Japanese wanted the yen to strengthen...(it did)...and they want it to strengthen more...(it will). I have heard private estimates from Japanese officials W-E-L-L U-N-D-E-R 100. These folks view the U.S. asset markets as I-D-E-N-T-I-C-A-L to their own in 1989...and, consequently, they do not want their asset managers to invest here, particularly in stocks. Also...these same officials are determined to impede offshore investment, in general, in favor of encouraging domestic investment...particularly in the JGB market. Most "Americentric" analysts simply refuse to accept the idea Japanese investors could prefer to own historically low yielding JGBs rather than U.S. bonds...which offer the highest real yields in the G-7.

SNIP

Fleck and Colin think that the Japs(not meant as a slur)have figured out that we are in a bubbl economy which is certain to burst soon. They have part of the puzzle in place, let me give you some other pieces to complete the mosaic. There's a thing called the real price of crude. Although most all crude oil transactions are transacted in dollars, currency rates do play a rather large role in the global oil markets. Platt's publishes a nifty little document which lays it out quite nicely I think. Check it out, the Japs are buying bonny light at TEN BUCKS A BARREL currency adjusted. Yeehaaaa! Did I mention that they are a net importer of approximately 5.4 million bbls per day? Did I mention that they will probably try to add to their already hefty reserve balance (currently 3 months of supply in tank at this time)ahead of Y2K? Did I mention that if they hadn't allowed the currency slide to occur, they would have faced higher oil prices to the tune of $2.268 billion yen in only a month? (yen slid from 122 to 108? by tommorrow = 14 X 5.4 milln bbs per day X 30 days.) If the yen fits, you must acquit.

For educational and research purposes only: SNIP

45--Real crude price -- USD vs international currencies New York (Platt's)--30Aug1999/517 pm EDT/2117 GMT BONNY INDEX REAL DUBAI INDEX REAL BRENT INDEX REAL LIGHT PRICE PRICE PRICE DMK 21.22 110.9 19.14 20.44 110.9 18.44 21.46 110.9 19.36 YEN 21.22 212.3 10.00 20.44 212.3 9.63 21.46 212.3 10.11 STG 21.22 103.8 20.45 20.44 103.8 19.69 21.46 103.8 20.68

(PRICES USD) INDEX -- SHOWS THE DAILY FLUCTUATION OF EACH FOREIGN CURRENCY AGAINST THE USD. IF INDEX > 100, CURRENCY IS STRONG AGAINST THE USD AND REAL PRICE PAID FOR CRUDE IS LESS THAN ACTUAL USD PRICE. IF INDEX < 100, CURRENCY IS WEAK AGAINST THE USD AND REAL PRICE PAID IS HIGHER THAN ACTUAL USD PRICE. --Platt's Global Alert-- [0045] [GE] [C] [GU] [GF] SNIP (PS anyone who wants to know what's up in oil should read Platt's Crude Oil Marketwire daily)

And here's the market assuming no intervention.

PLATT'S: Financial News: Dollar lower against yen and euro - PGA046 New York (AFP)--31Aug1999/1203 pm EDT/1603 GMT The US dollar was lower against the yen and losing ground against the euro in New York by mid-morning Tuesday. Traders expected the greenback to continue to fall against the Japanese currency as the Bank of Japan stuck to its policy of non- intervention. The dollar dropped to Yen 109.56 by 1400 GMT compared to Yen 110.60 late Monday, while the euro rose to $1.0572 against $1.0471. The yen was expected to keep gaining against the dollar as markets no longer expect the BOJ to intervene, said Dennis Heidt, a trader for Paribas in New York. The dollar also lost ground against other major European currencies, trading at SFr1.5127 compared to SFr1.5292 late Monday, while sterling was at $1.6062 against $1.5894.

[PGA] [NSAM] [JP] [ASIA] [EEC] [PLTN] [LEN]

And last but certainly not least, the JAPS are picking up the freight market for VLCC's themselves. Yeeehaaaa! You now should have all the pieces. Do you see the pattern?

139--Dirty tankers: VLCCs continue to climb London--27Aug99/1151 am EDT/1551 GMT The improved demand for VLCCs reported this continued to boost the AG market, brokers said. Rates for AG-Japan cargoes were talked up to w50-52.5 as supplies of modern units, especially for 1H Sep loadings, was described as "tight." One broker added that owners were taking a "tough" position on levels, and were now looking to push rates towards w60. However, the low w50s were seen as a more realistic level for the next fixture. Aframaxes remained firm, with both the AG and Indo markets talked around the w100-105 level, depending on timing and approval status. But there was little such encouraging news for the Suezmax market. Both WAf-USG rates and cross-Med levels struggled to attract more than w52.5, as owners continued to suffer from a heavy oversupply of tonnage. --Platt's Global Alert-- [0139] [C] [GS] [GE] [GF] [GM] [T]

This is the begining. Watch the freights, they're always 2 weeks ahead of physical tightening. Freight rates, going up. Crude oil, going up. IT HAS OFFICIALLY BEGUN. THE SIGNS ARE EVERYWHERE.

Now if I was really devious and suspicous like, I might expect Slick Meister and his oil friends (if he has any) to roll out some physical bbls. about now in some way. For example, if they had possibly encouraged some friends in OPEC to store physicals ahead of 2kay then as our old CRB starts to overheat the US markets and inflation, I'd be telling them to "Roll out the barrels". Or maybe fudge up the stats a little and show some phantom build etc. We'll see.

-- Gordon (g_gecko_69@hotmail.com), August 31, 1999

Answers

I am having trouble understanding why the US dollar is dropping. First of all, the Fed is raising interest rates and that usually strengthens the currency. In addition, foreign governments should want our dollar to be strong since we are net importers, and they should doing everything in their power to prop up its value.

Also, if it is generally acknowledged that we are the most advanced country in terms of Y2K compliance, shouldn't our currency become a "safe haven?" The metals are dead, so international money needs a currency for hiding, and which country has a safer currency than ours? None of this makes sense to me because it seems logical that the dollar must strengthen between now and the new year.

"Something's very wroooong here!"--Al Pacino

-- mike (maples@voy.net), September 01, 1999.


Mike, if the investment were strictly in physical dollars, you would be OK. what is happening is that the investment is in bonds with screwy interest terms, and in what are becoming accepted to be VERY price inflated equities.

the concern is that the equities will "normalize" (nice word for crash, don't you think) when the global circumstances warrant it. Probably sooner than later.

Chuck

-- Chuck, a night driver (rienzoo@en.com), September 01, 1999.


Mike, I read the article above to say that the Japanese government is taking steps to strengthen the Japanese Yen. The Japanese government and the Japanese citizens are facing their own liquidity crisis, so it appears natural that they want to stock up on their own currency.

So I suspect that they will sell dollars to buy Yen which has the corollary(sp?) effect of reducing the demand for dollars; so the value of the dollar weakens.

Re Flight to Quality: I suspect this is what has propelled the USA stock market to such highs over last 6-9 months. If/when investors see the bursting of the bubble it could be a stampede to sell.

Gold is slowly moving upward - I expect tangibles like gold and silver to move opposite of stocks.

-- Bill P (porterwn@one.net), September 01, 1999.


If you hold forgeign bonds you are facing risk in currency as well as risk in interest rate changes.

One sure way to LOSE money is to buy high and sell low.

If you buy the dollar when it is high and then have to sell when it is lower then you lose money. That is the first level of risk. It is required by any country that when you buy their bond you first must convert your money into their currency.

If the dollar was at 120 yen and you bought it there with your yen and the dollar fell to 100 yen and you had to sell dollars to buy yen back you would have lost 18% on your money. That's before you even think about what you may have lost in the bond interest rate risk.

If you buy a 30 year bond at 5% and the interest rate goes to 6% then you have lost 20% if you have to sell that bond in the open market. So a rising interest rate hurts those who hold bonds and are forced to sell them.

Add these two losses: 18% loss in currency trade plus 20% lose in bond trade equals 38% lose over all.

Now you can see why these folks are repatriating their money.

Because our trade deficit is skyrocketing people internationally will not be as willing to purchase our bonds, so the interest rate bid/ask will go up to meet these money manager's targets for profitability. One other thing which will add to this escalation in interest rates is the anticipation of increasing interst rates which will add pressure to the up side. This creates a situation in which bonds are losers unless you short sell them (which adds to the rise in rates).

The FED interest rates are not that interesting (pun intended) in terms of the overall market. The market in already purchased bonds is TRILLIONS of US$'s and completely dwarfs anything the FED can do directly.

The only time you really want to buy bonds is when the market rates have peaked and are trending down significantly. This happened in the early 1980's when the benchmark bond went to 15%. After Volker jumped the FED rates to 22% for borrowing money from the FED we entered a mini-depression for about two years. If you had put your moeny into bonds at 14% and waited a few years for the market rates to drop to 7% and then sold them you would have realized a 100% profit just in time to get into the stock market before it took off like a bandito.

Hind sight is always 20/20 and there are a million armchair millionaires as well!

-- ..- (dit@dot.dash), September 01, 1999.


>> I am having trouble understanding why the US dollar is dropping. First of all, the Fed is raising interest rates and that usually strengthens the currency. <<

Correct. But the currency traders are not yet satisfied that the amount of the rate increase is *sufficient* to offset their perception of the risk. The core problem is that our economy is strong, but still too weak to sustain the massive debt we have already incurred. And the debt is growing fast.

>> In addition, foreign governments should want our dollar to be strong since we are net importers, and they should doing everything in their power to prop up its value. <<

Actually, being a net importer is not a strength. Granted, there is the old adage that, if borrow $10,000 the lender is your creditor, but if you borrow $10,000,000 you become the lender's partner. But that only goes so far in your favor.

The world is undoing a shift in how they view the USA. They are waking up to the fact that we will have a hard time selling enough of our goods to repay our debts. They are getting worried about holding our debt. Dollars are just another form of US debt.

>> Also, if it is generally acknowledged that we are the most advanced country in terms of Y2K compliance, shouldn't our currency become a "safe haven?" <<

The "safety" of a haven is valuable to the extent that the threat is feared. The market consensus seems to be forming around the idea that the most real y2k threat is the flight to safety itself, not so much the threat that the computers will stop working. No one wants to be the last participant in an illiquid market.

>> The metals are dead, so international money needs a currency for hiding, and which country has a safer currency than ours? <<

The safety of the dollar has been undermined by weak corporate profits, a grossly overvalued stock market (a bubble), exploding debt, and the repatriation of the yen due to Japanese internal weakness. If the dollar continues to fall hard, investors will start to act in terms of a flight *from* danger rather than a flight *to* quality. No one is very sure what constitutes "quality", right now. Eventually, this question will be answered. It may take a while. But that won't stop the flight from the dollar.

The metals have not yet benefitted from y2k fears. They may soon, or they may not for some time to come. If a wave of bad debt and insolvencies goes crashing through the world, there won't be enough liquidity to drive *any* investment higher. That's the period when "cash is king".

-- Brian McLaughlin (brianm@ims.com), September 01, 1999.



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