Truth is a delicate
lining, not easily seen except in certain light - Ed Bugos
bulls beat up on the Yen Monday, pushing it back down to October's
low after a recent spate of dollar weakness saw it rise back up
to September's levels.
Not surprisingly, this happened as
CRB futures broke out of their three month consolidation to tap
the high made in 2000, intraday, but closed one point above their
best 2000 close for their best close in five years.
not surprised at the coincidence because the selling was seen to
be coming from offshore (or U.S.) hedge funds, as opposed to some
sort of homegrown panic; and it came on the heels of rhetoric first
by Japan's Finance Minister Masajuro Shiokawa who allegedly said
that the appropriate level for Dollar/Yen is 150-160 (recent range
has been 120-125). Then Dr. Yen weighed in with a warning that Japan's
deflation was a risk that's spreading through the global economy.
He must mean like in Argentina, Russia,
Turkey, Brazil, Mexico, South Africa, Australia, Canada, and like
in the US of course, since the PPI and CPI no longer are affected
by what's actually going on in the commodity markets (are Sakakibara
and Soros working off a debit at Citigroup or something... they
sound awful similar in their nonsensical themes these days, though
its none of my business!).
Of course Shiokawa is a dollar bull
too; he works for the government in Japan, and the dollar is their
reserve currency just the same. In what has been typical of many
Japanese policy statements, Shiokawa later said his comments were
misinterpreted. I don't know, maybe, maybe not, but maybe you can
make sense of it:
was quoted in a Japanese newspaper as saying during a speech in
the northern city of Sendai at the weekend that the yen was excessively
strong and should be around 150-160 to the dollar. "What I said
in Sendai is that the Japanese economy is not weak at all," Shiokawa
said. "If you take purchasing power, for example, it shows that
the economy is strong." His comments confused the foreign exchange
market - Reuters, Dec
Confusion, rhetoric, it all has the
same effect, and it tends to be loudest around trouble spots in
the dollar's technicals. Thankfully, Morgan Stanley has some sensible
comments to say on the subject:
said Shiokawa's range was based on the consumer price index (CPI),
but they said the dollar/yen rate has rarely been near CPI-based
PPP (purchasing power parity). Part of the reason is that CPI
includes non-traded goods. PPP is a way to compare living costs
between nations by looking at prices of similar items. The gauge
to calculate it can be anything from a hamburger to the CPI. Analysts
said using Japanese and U.S. September CPI data, the PPP is now
around 165 yen. That means what a consumer can buy for $1 in the
United States would cost 165 yen in Japan. But using the wholesale
price index (WPI) of final goods for the month, the PPP is around
103 yen to the dollar. And if PPP is based on the most competitive
export products and services, what a dollar buys in the U.S. would
cost only around 70 yen in Japan
- Reuters, Dec 3, 2002
That's more like it.
There are all sorts of fears about
Japan's banks in the backdrop, but apparently there is no fear about
US banks, and the distance they may yet have to fall from grace.
I can't figure out the (yen) bear's
claim. On the one hand, the bears say that a banking crisis is causing
yen weakness and will continue to, but on the other hand, they say
that Japan's banking crisis coincided with an uptrend in the yen,
and is the source of Japan's so-called deflation. It's almost as
if they'll pick either argument as long as it feels bearish for
the yen that day.
Let me make it clear that we're not
bullish on Japan. We're bearish on the Dollar, and in particular
versus the Yen because Japan has accumulated the most dollar reserves,
and because it has exported the most savings, proportionately. My
view is that the dollar is overvalued, period, but that the yen
has been a highly strategic pillar of dollar policy through the
late nineties, and continues to be such to the extent the yen carry-trade
The growing plausibility of inflation
targeting in monetary policy circles (despite limited evidence of
deflation risk since 1933 and the discrediting of Peel's Act even
before the Reichesbank folded) has given rise to increasing pressures
within the Japanese community favoring yen devaluation as a policy
tool employed to achieve a better pricing environment.
What Most Investors Don't Know
Of the past seventeen years, the yen spent ten of them rising against
the greenback, and since 1985 when Dollar/Yen traded between 200
to 250, it has generally been in an uptrend (see chart below). After
failing to turn the (primary trend of the) yen down in 1998, the
primary bull market argument is being tested again (it would be
more correct to classify the primary sequence in dollar/yen as neutral,
with a bearish bias developing over the past two years, but that
would omit the fact that the prior bull market support has yet to
be taken out at the 143 dollar/yen rate).
The long term rise in the yen against
the dollar is easy to understand if you accept that the higher rates
of dollar inflation relative to yen inflation over the period has
anything to do with their valuation. Of course, it's actually more
complicated because these inflation (indicated by money supply growth
rates) differentials don't always explain the short term moves in
currency relationships. And when one considers the claim that Japan
has been a strong source of foreign capital for the US economy,
the difficulty in understanding the yen's long term uptrend grows.
To understand it means to review
the past. We'll try and make it painless.
The yen's biggest gains came during
1985 through 1988, and 1990 through 1995. Both periods are marked
by dollar weakness, but in the former period during the eighties,
Japan's inflation rates surpassed US inflation rates and gains in
the Nikkei overshadowed gains on Wall Street. After the yen peaked
in 1995, the opposite occurred. US inflation rates surpassed Japan's
and their stock markets outperformed everyone's save the most speculative
developing markets. Those gains added to the dollar's value, ephemerally
I suspect, which was further helped by widening interest rate differentials
between dollar and yen assets. When this happens, a currency sees
a rising liquidity premium, or as I call it, an investment premium.
It may look and feel like deflation, but you can bet it isn't by
looking at what's happening to equity valuations simultaneously.
The significance of the yen-carry
trade is that it came to dominate the dollar/yen relationship in
the late nineties (the peak for the yen against the dollar occurred
in 1995 - since then it has fallen into a neutral primary sequence,
and has spent more time falling than rising).
The trade is the result of a widening
interest rate differential in the US' favor, particularly at the
short end, as the Bank of Japan tried to support its ailing banking
industry through the nineties, in the aftermath of prior eighties
It became increasingly profitable
to borrow yen and invest in dollars after 1995. This was the basis
of the yen-carry trade.
After 1998, as interest rates in
the US were lowered to shore up the failures of at least one large
US hedge fund and perhaps some banks, the dollar started to fall
against the yen again (actually it began earlier... as the US stock
markets peaked in July). By 2000, the dollar had bottomed, and has
again been rising relative to the yen until this year at any rate.
There is lots of confusion in this
market today (technicals too). We'll try and simplify our point.
Managing Liquidity Premium To
Stabilize FX Rates
Some traders reckon the rise in the yen since 1985 is a consequence
of Japan's banking contraction, and proof of the deflation they
keep talking about, as if currencies only went up due to deflation.
They reason that as the US
goes in the same direction - monetary bust - they'll have similar
deflationary symptoms to contend with from the value of the dollar
as it rises when the mighty US banks call in their overseas loans.
They omit a few facts. There is a
strong theoretical and factual correlation between the value of
a currency and the value of the bank shares doing business in that
currency, or more accurately, between the value of the currency
and the real rate of return potential in financial assets denominated
in that currency. This, loosely, is how we define the currency's
liquidity premium after all.
Moreover, it's laughable to think
that America's trading partners have nothing to say about the value
of the dollar they help support. US trading partners have probably
acquired more dollar credits than entered into dollar liabilities,
which is indicated by the fact that the US investment income account
fell into the red over the past few years.
The rise in the value of the yen
in the eighties wasn't tied to deflation. It was the consequence
of a rising liquidity (investment) premium for the yen, which was
reflected by the richer relative equity values in Japan at the time.
The rise in the value of the yen
from 1990 to 1995, however, is still seen to be the result of deflation
by most currency players; 1990 after all was the peak in Japan's
But something else occurred in 1990.
In the eighties, as we mentioned,
Japanese inflation rates soared, and the difference over US inflation
rates increasingly widened so that Japan saw it eventually manifest
in an incredible real estate and stock boom. But after 1990, US
inflation rates began to outpace the Japanese inflation rate, and
continue to until this day.
If you compare the two periods, before
and post 1990, you'll notice that in the first half of the eighties,
the yen sagged and in the second half, as the inflation caught on
to financial assets, the yen soared, peaking only one year ahead
of the Nikkei.
The US dollar followed the same path
in the nineties. It sagged in the first half of the nineties, but
US inflation rates accelerated with a sharp increase in equity values
after 1995, which resulted in a soaring dollar, peaking one year
after the peak in US stock markets (this is the Paul Krugman quantitative
easing model at work btw).
The result was a 10-year bull market
in the yen (1985-1995): the first half due to a rising investment
premium, the second due to a sagging greenback. Now, US policy makers
would like to see a 10 year bull market in the greenback. The first
five years is behind them and it was marked by a rising liquidity
premium for the dollar as was the case for the yen in the first
half of its 10 year bull market. The hope of dollar bulls today
is effectively that policymakers will guide a weak yen policy similar
to what was said to be a weak US dollar policy from 1990-1995 in
its day, with the aim of sterilizing their relative inflation policies
and coordinating a global investment boom in perpetuity. In other
words, its Japan's turn to bite the bullet so to speak.
Naturally, we might expect this coordination
of monetary policy to continue indefinitely, with the US dollar
only half way through its bull market (that started in 1995), and
the next five-year period dominated by yen weakness as Japanese
inflation rates are expected to begin outstripping US inflation
rates as they did in the early eighties, in a bid to ignite a new
asset boom in Japan (down the road) and save the global economy
from deflation! no less.
There are big differences between
now and then, however, in the context of this seesawing of monetary
policy in order to stabilize long-term foreign exchange relationships,
and sustain a global monetary boom indefinitely:
- Interest rates have persistently
declined (to near zero now) in both countries since 1981, approximately
when this global monetary experiment began. Thus their use as
a tool to perpetuate the global inflation scheme has been all
but spent. New tools are required. Rhetoric won't cut it (by the
way, how come CEO's aren't allowed rhetoric?).
- Despite the ten-year bull market
in the yen (1985-1995), most of the world's assets never were
disproportionately invested there, and over the past twenty years
have still largely flowed into dollars.
- Yen strength in the early nineties
was buoyed by dollar weakness and a repatriation bid for the yen.
Today, yen weakening policies abound, but there is no repatriation
bid for the dollar.
Today, the ability to devalue the
yen rests with increasing the relative inflation rates in Japan
(we're not talking about the CPI by the way) and a repatriation
bid from Japanese assets to US assets. But while the Japanese may
have had a surplus of dollar investments in the early nineties,
to buoy the yen, there is no such surplus of Japanese investments
by US interests today. There's just the ability to short them, and
to carry on the yen-carry trade for as long as it will stretch.
Moreover, to legitimize the yen-carry
trade, the dollar needs either a bull market in US shares or bonds,
such that it's profitable to borrow in yen and play
There is no other currency in the
world dependent on an inflow of foreign savings to supplement investment
policy to the extent that the dollar is today. There are many in
the same boat, but not as large.
Dr. Yen Has It Backwards, the
Dollar Is the Reserve Currency
On the other hand, there is hardly a currency in the world less
dependent on foreign savings than the Japanese yen. This doesn't
mean the Japanese economy is better, only that this is the way it
Of those countries, whose currency
values are dependent on the uninterrupted inflow of foreign savings,
many have seen their currencies devastated, as
in Asia during 1997, or Russia in 1998, or the Latin American currencies
over the past year. But these are the smaller replicas of the US
Make no mistake, they are replicas.
The US dollar is not invincible, and there is no sign of deflation.
In fact the dollar is so wobbly, the Fed sent out their new guy
(Bernanke) to deliver a speech claiming dollar devaluation as their
idea, just in case the free market tears into it on its own accord
in the near future.
The dollar is an international reserve
currency, the yen isn't. Consequently, deflation and inflation don't
spread from Japan, they spread from the United States, and what
is happening is that dollar devaluation is going to cause deflationary
symptoms every where else in the world including Japan. But it won't
really be deflation.
Profligate US inflation policies
tend to put pressure on trading partners to pursue the same policies
or suffer a deflationary wrath, and sooner or later, if they don't
keep up with US inflation rates, and similar policies, "relative"
deflation is what they'll feel (feel is different than what is)
as their currencies rise in value. Weaker currencies and monetary
unions bust sooner if their inflation rates run too high, so they
don't experience the deflation until later, when the value of the
Sooner or later, inflation is precisely
what makes a currency weak. The schemes that have been put in place
to support the dollar as an international reserve currency have
been all but compromised by years of profligate money and credit
inflation, and today, there are increasingly fewer candidates willing
to make themselves the sacrificial lamb of US dollar policy. Japan's
economy may indeed be in trouble, but so is the dollar, and dollar
devaluation is about to throw the world economy into what will appear
to be deflation, in as much as those foreign currencies rise in
value, but what will actually be increasingly inflationary since
the dollar is also everyone's reserve currency (i.e. the one most
banks have most of their assets invested in). Such is prognosis
of the Fed's inflation trap.
Will They Confiscate Your Gold
This Time Around?
One of the questions investors often ask me is what are the chances
that the Fed, or government, would nationalize the country's gold
mines if they felt they had to - which means, to shift control over
the means of production to the government in a vain attempt to guarantee
the State a source of gold supply to sustain the value of the overvalued
I'm bullish on gold prices, obviously.
In my view they could go to $2000 in the context of a primary bull
market. Bull markets in gold can be quick, or they can be gradual,
though even if they're gradual, they tend to occur over a shorter
time frame than the typical bull market in paper assets we get in
between periods of dollar devaluation. In my own market experience,
bull and bear swings tend to over shoot more often than not. I know
many of you would say the same. By the time gold prices would get
anywhere near $2000 per ounce, we may be looking for an $8000 price,
or maybe we'll be selling. Anyone that thinks they'll be selling
before the rest of us is likely to sell way too early, while anyone
not thinking about selling at some point is likely to be someone
It may be true that a bull market
of that magnitude would reflect a global economic crisis. People
don't like to be bullish on gold because they think they're being
pessimistic on their economy. This could be corrected simply by
emphasizing the truth that it isn't an economic crisis at all. It's
a monetary crisis.
During such a crisis, the markets
are trying to heal the economy, whose structure has been dislocated
through the intervention of excessive inflation of money and credit
in the prior years leading up to the crisis. These monetary cycles
have nothing to do with capitalism, but some people would love to
believe they do, since money after all is the basis of any free
exchange of goods (which is what capitalism comes down to) and they
are politicians employed in the manner of interfering with the free
flow of capital and free exchange of goods with the aim of transferring
wealth from hard working folk to lazy pompous bureaucrats who think
they know everyone else's worth.
It's this system that breaks down
when we have monetary busts. It's a political crisis, but it becomes
an economic crisis to the extent
most people have become vested in their corrupt leaders' ideas.
Here's the worst part. If the reaction
to such a turn of events is to confiscate private property (in this
case gold and gold production), it would bring further punishment
to the economy, and by virtue, most people.
It would be like the kind of plundering
of ancient civilizations' gold that the world's most inflation prone
economies have historically resorted to.
It would be imperialism at its height. It would be George Lucas'
Star Wars coming to life.
In every instance, gold has got a
bad wrap because it has been the lust of mankind's worst travesties
throughout history, and so, there are those who believe it is itself
the root of all evil, so to speak. Some people believe money is
too, as if, without money, the people doing evil deeds wouldn't.
The truth of the matter is that the
typical monetary bust drives gold demand, not some voodoo magic
spell when it glitters. The inelasticity of supply is what makes
gold prices so volatile, as the academics like to say. How would
government control over the means of production alleviate that problem?
I mean, it could in the short run, but in the long run gold supplies
would have to be quickly exhausted.
Please Tax Us Some More
After all, it's the inflation policies that are well known tools
of wealth transfer and hidden taxation, and which drive gold demand
in the long run (i.e. when they fall apart, often unpredictably).
This is the tax.
Every 17 or 20 years, whatever has
been the case, we are taxed by the consequences of prior inflation
policies, which is that we can't afford anything because the currency
debases. This happens when they can no longer "control"
the inflation. Then, when our kingdom needs to acquire more gold
to sustain this ongoing looting of the people that work hard for
their wealth, we send out an
Inquisition to find the Incas guilty of not believing in our religion,
so that we can confiscate their gold! It's not rocket science, just
Can you see my point? So now when
we see events unfolding that suggest we're experiencing one of these
typical monetary busts, the idea that nationalizing the gold mines
could be a remedy has surfaced. Politicians are seen to have little
trouble persuading people that this is where FDR went wrong, that
he should have not just outlawed gold ownership, but also that he
should have outlawed private control over the means of gold production.
Gold is still the bad guy. We can
continue plundering each other so long as we have a scapegoat, is
Look, if one accepts that the great
nineties bull market was at all a bubble then they must also acknowledge
it wasn't real by definition, to one extent or another. If it wasn't
real, it was the result of inflation, or too much money (currency
and credit), as it always is.
Now, if that were the case, duh,
how would the abolition of gold ownership and/or the private control
over the means of production solve that problem, or prevent it from
reoccurring? If not gold, who or what could discipline reckless
monetary policies? Larry Kudlow?
No way. You see, gold isn't the problem.
Neither is money. The problem is too much (easy) money. It's impossible
and calculating to isolate the aftermath of such policies from their
prior contribution to the crisis at hand. But this is what is effectively
done when remedying the crisis by alleviating the symptoms, as if
there wasn't already a cure.
To Be, Or Not To Be, That's The
Granted, the cure is hard to swallow. It would taste worse than
the oldest and warmest cod liver oil you could imagine. The cure
is to abolish central banking and embrace private property. They
can't coexist, which is why the answer to the question at hand today
is going to come down to a choice between abolishing the Fed and
abolishing gold ownership/production.
Those fearing an assault on gold
ownership fear that presented with the choice, people will opt for
a scapegoat and take the path of least resistance, a reasonable
expectation in light of events.
Other people, such as Mises, like(d)
to believe there is nothing the government could do to win in the
end. He believed in the power of the market not only over the other
economic alternatives, but also over the ignorance and corruption
of a society bred under generations of inflationist doctrine. Of
course, he also didn't mean that government couldn't grow; just
that there was no end that could justify it, and that every attempt
by the government to overcome market discipline must inevitably
Personally, I'm mixed.
Today, It Would Be A Buy Signal
However, I do believe "the crisis" (bust) has a ways to unfold,
yet, before this choice is brought to bear, and that investors will
stand to make much more money between now and then by investing
in gold and gold shares rather than betting on the house. I believe
that before this choice is seriously considered, dollar devaluation
will have at least been tried if we're wrong about the market dictating
it. I think gold prices will be much higher than they are today,
so the risk to our gold positions today stemming from the nationalization
of gold production in the future I believe is minimal, particularly
relative to the alternative investment classes.
In fact, even the prospect
of serious consideration to such a scheme by any important government
body today would be a bull market signal like you wouldn't believe.
For, the one thing holding back a
gold bull market today is the question of whether gold is really
money. If the Fed or Treasury were to bring up the prospect of nationalization
today, when they're still trying to keep the strong dollar, and
while the bullion banks are still short, they would be shooting
themselves in the foot. It would be an admission that gold is money,
which is the one thing they've worked
very hard to keep from people for decades.
Even Roosevelt's administration realized
that they had to devalue the dollar first to make their plan of
restricting gold ownership work.
There is no way that such a plan
is bearish for gold at current prices.
The ability to expand credit and
money without resulting in an instant proportionate devaluation
of the currency rests 100% to the credit of US dollar policy, and
the ignorance of economic participants, to the extent they aren't
able to differentiate real economic activity from nominal economic
activity at any rate.
So to ask, "Why couldn't they
just print all the money they needed to buy the gold producers outright,"
is to not realize that they don't print money. They print (create)
currency and credit, and fool us into thinking its money. The moment
that the nationalization of the nation's gold mines became a serious
consideration, therefore, the jig would be up, we would know the
dollar wasn't money. The market would first have to adjust to the
new perception, and they could print all the currency they wanted,
but still couldn't afford to buy the gold production because gold
prices and gold stocks would rise incredibly fast.
Of course, the government could come
out and tell gold producers they have no choice but to sell out
at a fixed price (below the real market). But your guess is as good
as mine is in determining what value gold would have to rise to
in order for such a plan to become politically feasible in what
is still the most free market nation in the world. In other words,
the mere threat of gold's ascent isn't likely to initiate the scheme.
Thus, I consider the question of
gold ownership restrictions and the nationalization of gold mines
moot at current gold prices.