"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

Will the Bank of Japan come in to the Forex markets this evening?

That is the big question weighing on the minds of currency traders. The initial knee jerk move higher in the Yen, due mainly in part to repatriation of funds by Japanese companies and citizens to the mainland, can explain the rally in the Yen during the early part of this crisis. However what now appears to be happening is a potential unwind of the Yen carry trade which has been blowing up due to the massive move away from risk. The price action in the Yen compared to the price action of the US equity markets is evidence that many hedge funds have been borrowing Yen and then using that cheap money to leverage up on US stocks. While the carry trade using this particular currency is no where near the size it was back in 2008, it is still very large. Back in 2008 when the credit crisis erupted in the US and spread around the globe, the Yen staged an enormous rally.

Hedge funds, which had acquired massive leveraged positions using the Yen as the funding currency, commenced a headlong rush to the exits en masse. In effect they had acquired a massive short Yen position which the Japanese monetary authorities were more than happy to condone. When the Yen began moving higher, suddenly the trade began souring as gains in the leveraged positions were being dragged underwater by losses on the currency front due to gains in the funding currency. As commodities and stocks were sold off, the trade because to collapse. Their panic to deleverage forced the Yen sharply higher even as the stock markets and commodity markets were obliterated to the downside.

Once again we can see what what appears to be an exact repeat of late 2008. Given the fact that the Japanese economy has been devastated by recent events, the last thing that the Japanese monetary authorities want to see is a soaring yen, which will effectively cut off their export markets at the knees by hurting their price competitiveness on the global markets.

What we might see begin to happen is the BOJ coming in and beating the fire out of the speculators by selling enormous amounts of Yen on the foreign exchange markets this evening or very soon. One wonders what they might do with all the US Dollars that such action would accumulate in their coffers. In the past they would sterilize the intervention effort by purchasing US Treasuries.

If that were to happen this time around, the Fed could sit back and watch the BOJ do its QE work for it.

Again, this situation is very fluid and can turn on a dime but it is highly unlikely that the BOJ and the Japanese Ministry of Finance are not keenly watching what the hedge funds are doing to its currency.

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.


  1. Hi Dan,
    Not really understanding all this currency issues ( way to complicated for me at least ) that you talked about above ,I guess for me if the BOJ does intervene in the markets as you suggest, what effect will it have on gold and silver prices in the short term.

  2. Hi Dan - thought you might be interested in this blog from MIT on the nuclear situation.


  3. Robert,

    What Dan was trying to say is that Hedge funds were selling Yen to purchase Dollars to invest in the US markets. This only works if the underlying currency (Yen) does not appreciate in relation to the other currency (USD), since an appreciation on the Yen effectively wipes out any gains you might have on the other end.

    Since people now seem to want to delevarage, they must purchase Yen and this creates pressure to the upside. The BOJ does not want that since a Yen appreciation would hurt exports.

    To answer your question, if the BOJ goes ahead and dumps Yen on the market it would put even more pressure on the PMs.

  4. RickR--thanks a lot for the explanation .


  5. About the situation in Japan:

    My wife is Japanese and we were scheduled to move to a place outside of Tokyo next week because I got a job there. Needless to say, we are not going now. Her family is OK (they aren't located in the immediate area where things are the worst), but people seem to have been in denial about the growing problem and slow to recognize that they need to make precautions in case things really turn for the worse. For example, my employer in Japan still thinks that people will go to places were the radiation level is 300 times above normal and they have yet to issue a warning to those they (still) expect to show up in the areas where the radiation level is climbing by the minute.

    There is a precedent for all of this: the great Hanshin earthquake of 1995 in Kobe--the government was slow to respond and people had to fend for themselves. In the hardest hit areas this time, sufficient food, water and fuel for heating is not getting to citizens, despite Japan's wealth, yearly earthquake drills, and a large self-defense force, the government is irresponsibly letting the stress levels rise among the most severely deprived because it is not providing adequate relief efforts for them. Supposedly, some of them are getting rowdy now. Moreover, the government--and most of the media outlets (which are tied to the hip of the government, especially the major newspapers) can not be trusted to tell people exactly how bad things are. In fact, the information now has changed to a trickle and the German government is challenging the Japanese government to be more forthcoming about the real situation. Remember, this is a country were doctors don't tell you that you have cancer. They might tell your loved ones, and then it's up to them to find the strength to tell you the truth (and many don't). I used to live in another state (prefecture) in Japan. A doctor there (who was a student of mine) said that the cancer rates of his patients who lived around the nuclear plant in that prefecture were higher than average, yet the government was in denial about this, as well as the citizens themselves. The Japanese are incredibly hearty, yet also peculiarly adverse to reality and the truth. When things go bad, they get stoic and tough, and then soon give up in fatalistic fashion ("shoganai" attitude). These national characteristics lend themselves to people responding to emergencies very slowly, or not at all.

    The Japanese government is the biggest problem in all of this. To evacuate people in such limited numbers, to do so only in narrow concentric circles around the nuclear power plants, to tell others to stay inside, and then to do these things (almost as if grudgingly or not to "panic" people) only at the last minute is asinine. People living in ever wider circles away from the nuclear power plants should already have been evacuated while the situation was less critical and still manageable. When they finally tell people to get out of those areas, there will be no gasoline to motor out of the area, the roads will be clogged and there will be chaos. If Japanese were taught to think for themselves more, more of them would already have initiated a disaster plan on their own. Instead, they look to the government for guidance, a government that is sleeping at the wheel.

    Bottomline, this situation is going to get worse and the government, in the end, will be excoriated for its response, or lack thereof.

    Guess for yourselves what this all means in terms of PMs, commodities and the yen.

  6. BOJ has already expanded their QE program from 5 to 10 Trillion Yen (120billion), to have the scale of QE 2 in the US, they need to implement the full size 30 Trillion Yen. As the government already indebted up to 200% of GDP, they are treading a fine line going forward. Japanese corporate, government and individuals own up to 850 billion worth US Treasuries. If they need to dip into their savings for reconstruction. Keep an eye for the yield curve on US debts.

    Bank of Japan Policy options


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