Correlation: USD/JPY Vs. Gold

Something fundamental has changed since the 2008 crisis. We see the creation of a yen carry trade on the gold price. Whenever the yen drops against the U.S. dollar, the gold price falls with it. This correlation only started after 2008.
//research.stlouisfed.org/fred2/graph/graph-landing.php?g=Q8V
Due to the high debt burden of Japan, bond yields should have gone up in Japan. This has not happened because the Bank of Japan has been buying the bond market with their QE monetary policies since 2013. The consequence was that bond yields in Japan kept falling while the yen deteriorated (this is what we call hyperinflation). These were the 2 perfect conditions to initiate the yen carry trade. Yen were borrowed, U.S. dollars were bought and equities were pushed upwards while gold was pushed down.

For more info on why Japanese bond yields can stay low you can read this.
http://www.levyinstitute.org/pubs/wp_818.pdf

In yen terms, gold has stayed flat.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=Qsd

Buying Japan is Picking Flowers in Front of an Incoming Train

Japan is undergoing a lot of changes today and one of the most important changes to investors is their fiscal situation. In a previous post almost a year ago, I analyzed the dismal fiscal situation in Japan, pointing out how their budget deficits and debt burdens are growing. I want to make an update on that as investors are focusing more and more on Japan these days.

The Ministry of Finance Japan has issued a new report on the fiscal situation which can be found here. This report is dated from December 2013.

Let’s first focus on the trade and current account deficit in Japan. Both have been deteriorating rapidly in 2013. In fact, we are hitting new lows as we speak. The primary reason is that the yen has devalued a lot since 2013. As I noted earlier in other posts, the currency valuation is correlated to the deficit. If the valuation of the currency of a country goes down, that means that they will need to import products at a higher price and they will export products at a lower price. This naturally leads to a higher deficit. Evidence can be found in the soaring costs for importing oil to Japan. Oil imports basically almost doubled in price as noted in this article.

Chart 1: Japan Current Account and Trade Balance

If we then move on to the budget deficits, there is a bit of light at the end of the tunnel. The deficit to outlay ratio (which gives the likelihood for hyperinflation) has come down from a peak of 62% to 48% which is an improvement, but we are still in hyperinflationary territory (ratio above 40% is hyperinflationary).

Chart 2: Deficit to Outlay Ratio Japan

Chart 3 illustrates that the government has cut back on spending (red chart) and the budget deficits have come down (green chart). It also shows how tax revenues in Japan (blue chart) have gone up due to a rising Japanese stock market. This rise in tax revenues has decreased the budget deficits in Japan.

Chart 3: Japan: Tax Revenue, Expenditures, Budget Deficit

Now we come to the most interesting part of this analysis: the interest payments on government debt. To find out about this, go here.

Euro surges against U.S. Dollar and Japanese Yen

As I predicted here and here, both the U.S. dollar and the Japanese yen are underperforming the euro. This is mainly because the central bank balance sheets of the U.S. and Japan are inflating, while the balance sheet of the Eurozone is shrinking/flatlined.

Central Bank Balance Sheet Expansion is Bad for the Currency

Moreover, we see that the Eurozone has a trade surplus while the U.S. and Japan have a trade deficit, which according to this correlation below, is good for the euro and bad for the U.S. dollar and Japanese yen.

Deficit is correlated to Currency Valuation

At this moment, if all things stay equal, the euro will continue its rise against the U.S. dollar and Japanese yen. An extra catalyst following the asset-quality review (AQR) is that the European banks need to increase capital next year and they will need to buy euros for that.

This also means that U.S. and Japanese bonds will continue their decline as following correlation between currency and bond yields suggests.

You see, this is the power of correlations… Maybe I should rename this blog to: “Correlation Economics”.

Why you shouldn’t buy Japanese equities

This is why you shouldn’t buy Japanese stocks to profit on it as an American citizen. As the Nikkei goes up, so does the Yen decline against the USD. 

So your profit is zero.

Source: Eureka Report

Japan got its inflation going

Japan got its inflation allright, USD/JPY just went to 100 and I see 200 coming soon.

USD/JPY

Strength in currency: a good thing?

Today I was thinking about the yen dropping against other currencies. Mostly, such things happen when governments print money. But also when countries post deficits in their current account balance.

The mechanics are as follows:
A country exports stuff to other countries and receives money in foreign currency. Let’s say Japan exports Playstations to America and receives US dollars. Japan will of course want yen, and will exchange those US dollars into yen so that they can buy things with yen in their own country Japan.

If Japan exports more to the US as the US exports to Japan, then more money will flow to Japan than to the US. So more US dollars flow to Japan as yen flow to the US. Which means more US dollars need to be converted into yen, which makes the yen rise.

Conversely, when Japan has a trade deficit, like today, then the yen will drop against other currencies out there. So basically you want your currency to strengthen, which indicates that your balance sheet is improving.

Strength in currency:
Strength in currency has other positive effects. If your currency is higher than other currencies then you can buy more stuff. Let’s say the oil price is $US 100/barrel. If the yen goes up against the US dollar, the oil price is still the same, but Japanese people can buy more oil, which means their import costs go down, which is good for their balance sheet.

People will say though, if your currency goes up, you will export less. I think this is a complete baloney! When your currency goes up, you can always reduce the prices of your goods that you sell to foreigners. You will have less revenue (because you sold for a lower price), but your currency went up (which means you didn’t lose any money). You will still have the same real revenue as a company, currency adjusted. Of course, when you reduce the price of your goods sold, you should also reduce the wages of your employees, otherwise costs will go up. But the employees shouldn’t have a problem with this, because they still have the same buying power as their currency just went up against other foreign currencies. And if they had money in the bank, that money just went up in value against other currencies.

Generally, companies will benefit though, because their import costs went down due to a strenghtening currency.

Conclusion:
When your currency goes up you will always benefit:
1) You can buy more stuff (oil, food, gold…)
2) Exports will NOT go down as you can always reduce prices of your goods sold, and reduce wages of your employees. Import costs will go down as the currency went up against other currencies.
3) Employees aren’t affected as their reduced wages are compensated by a higher currency. Their buying power stays the same.
4) Savings in their own currency will appreciate in value.

I would love to have a discussion with anyone who doesn’t concur with this thesis.