"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Wednesday, March 16, 2011

This is not 2008

I wish to add some additional comments to the previous posts concerning the Japanese Yen, the carry trade and the potential for a QE program commencing by the Bank of Japan as a response to the events in that nation.

There is no doubt that a yen carry trade unwind has been occuring. See my earlier post about this where I discuss the price action of the Yen in comparison to the equity markets in general and the commodity markets.

I noted at the end of that article the following:

"The difference between what happened to commodities and other assets in 2008 was that the Fed was not engaging in any form of QE at the inception of the crisis. It could well be that we now have QE3 set in stone."

A subsequent post then explained my rationale for the Bank of Japan to engage in its own version of Quantitative Easing.

Let me go a bit further here and make a quick case for why this is not 2008 and why we do not need to fear the kind of meltdown in the commodity markets or the equity markets for that matter as occured back then.

First, once the Japanese are able get those nuclear reactors under control, one way or the other, this situation will have been priced in and the markets will reverse higher because that is the nature of markets - they price in the worst case scenario and then once that occurs, it is already discounted and the market then generally moves higher as all the bad news is already accounted for by the then current price level.

In 2008, no one knew the extent to which the tentacles of the derivatives that blew up reached. It was one shoe falling after another. An institution would fail, hope increased that the worst was over and then BLAM, down went another institution. It did not take long for investors to realize that the problem was not going to be dealt with quickly. Indeed, they soon began to understand how intertwined, how pervasive, and complex the problems were. In short, the market feared a near complete collapse of the entire financial system!

Here the situation is known ( an earthquake and the damage associated with it and the subsequent tsunami) and the market is factoring in the worst case scenario of a nuclear meltdown and the effects associated with that. That has forced an avalanche of selling by the hedge funds who are once again proving to be a plague on our financial system by their abuse of leverage. As they unwind that leverage, they sell assets purchased by the use of borrowed money, in this case the yen, (among other currencies including the Dollar to some extent), and then are forced to buy back the yen. If they had learned anything, they might have actually hedged some of these leveraged carry trades by taking some long side protection in the Yen itself but that is another story for another time.

Unlike 2008 therefore, this is not a SYSTEMIC EVENT. It is all connected to the events in Japan and even though it is forcing a yen carry unwind, it may have already run its course because the event, even though it is serious, is a temporary one, which will be resolved. Traders are not peering into some blind unknown as they were back in 2008 because quite frankly, the world had never before in its history seen anything like the "meltdown" associated with these financial weapons of mass destruction. No one knew what to expect and no one knew how it would all end.

Contrast to the events in Japan could not be more evident - while there is a serious knowledge deficit regarding what is actually occuring inside the nation of Japan particularly as it concerns the status of the nuclear reactors, there is a point at which this story will eventually come to a conclusion. In that sense, there is no unknown. The events will play out to their tragic ending leaving thousands of our Japanese brothers and sisters dead, their lives upended and a significant part of their nation in shambles. What will happen however is known - the nation will rebuild and the citizens will pick up the pieces of their lives and go on.

Second - back in 2008 there was no Fed QE and there was no Japan QE. Once the QE was announced by the Fed near the end of 2008, the hemorrhaging stopped and when the program actually commenced in March the next year, gold and the rest of the commodity world took off to the upside. The action by the Fed seemed to take the unknown out of the situation in the one sense that many believed that the Fed would not allow the financial system to utterly fail and when many had believed it would.

My strong belief is that the panic selling we are seeing in the markets is tied not to the earthquake damage or even the tsunami damage but AT THIS POINT to the unknown associated with a nuclear issue. That has jarred confidence and stirred fear and people are selling first and asking questions later.

The truth is the Japanese are going to require massive amounts of raw materials to rebuild their battered infrastructure and that is going to put a firm bid under the base metals and other commodity markets a bit further down the road. The implications are more of a short term bearish thing, long term bullish for commodities in general but particularly bullish for gold because of the implications associated with a QE program by another massive economy. My guess is that as soon as the nuclear issues get resolved, the markets will rebound.


  1. Per the usual.....excellent stuff Dan!

  2. Can't thank you enough Dan. You are a voice of reason, logic and experience.

  3. I like this assessment.
    But I disagree with the assumption that "What will happen however is known", that rebuilding will occur and life return as per before. If the worst case nuclear scenario plays out and Tokyo's millions are 'radiated', the assumption is wrong. Hopefully this doesn't happen.

  4. Sorry, but I don't buy that the potential nuclear destruction of Tokyo has already been priced-in.
    There are too many sequelae to that to contemplate
    and most of them would be negative.

  5. I agree that "this is not 2008" BUT you, in my opinion underestimate the possible economic collapse of the Japanese economy. Here you have 126M people living in 395000 Square kilometers and IF the nuclear situation turns to the worst you will have a dead country. The hedgies are too arrogant to even think that this is potentially lethal for Japan and therefore for the economy of the rest of the world.
    The ONLY way this could turn as assessed by you -rebound of the stock market- is IF Japan wins against the reactors,,,and based on what we see in the news, this is far from being a viable ending.
    I sold all my equities 2 weeks ago -based on the Middle East situation- and won't buy back for sometimes...
    For all my Japanese friends, I really hope my assessement is wrong

  6. Thanks Dan, for keeping your head while all about us are losing theirs.

  7. Dan, you are the man...but I'm leaning toward Hubert's comment. While the eq and tsunami have been figured into the markets this nuclear event has not imho. Think Chernobyl and what a wasteland that created and then think of the potential for a meltdown turning Japan into a Chernobyl.

    If they don't get a handle on this and it goes worse case, who would want to live there or work there? Would the water and food ever be safe? And what would be the impact of a dead Japan be on the rest of the world's economy and the currency crisis?

    I pray they get those reactors under control but I'm not optimistic with France, Russia, the EU and US nuclear regulator spokemen announcing they see a total meltdown.

    At this point a rebuilding of Japan has to be on hold until after this nuclear event is resolved one way or the other. I don't believe the markets have figured in a nuclear meltdown in Japan, impacting its life, it's water, food and industry for years to come and that impact on the world.

    Thanks always for your thoughts.

  8. Thank You Dan, for sharing this view. I am still not sure for myself if I believe this scenario or rather go for the more catastrophic one. Zerohedge already posted on "All Mizuho ATMs In Japan Have Stopped Working". The implication of the disaster in Japan, even net of the nuclear inferno, can be very far reaching - e.g. Japan will need cash to rebuild and cannot buy PIIGS bonds for the time being. Japan will need food and nobody knows where the winds will blow all this radioactive waste and how much arable land will get contaminated. There were already posts in zerohedge on radiation in drinking water. I am afraid even if there is a happy end with the NPP the effects of the earthquake on the global financial system will unwind for some time being in rather unexpected ways.

    After all I am not sure which scenario will play out but it is really helpful to read your views.


  9. I think you are right, Dan, but the story is indirectly intertwined since the world economy isn't exactly very stable and any fear-provoking event may prove to be the well-known straw. I think this is the general fear (and not the fear from any nuclear fallout or whatever), especially in your circle of friends / readers that don't buy the all-is-well, the-market-is-free, apple or netflix...

  10. Thanks for your view of things based on having seen so many catastrophes both systemic and non-systemic.

    As far as when to apply the recovery view one of the key phrases is 'once the Japanese get those reactors under control, one way or another'.


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