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Veneroso - Japan Pushed Off The Face Of The Earth?

Bill,
Half a day after I wrote to Midas about the strength in the Yen vs. everything else, I learned at Naked Capitalism1 that Frank Veneroso just analyzed the same subject in a piece titled, “The Yen: Will The Traders Push The Land Of The Rising Sun Off The Face Of The Earth?” Here are some excerpts from Veneroso on Japan’s dire straits:

“1)The Japanese industrial production data and METI forecast was bad beyond all imagining. Industrial production might fall by 1/3 in the 12 months ending in January. It could fall in a mere four months between November and February by more than half the U.S. Great Depression decline which took almost four years.

2) Nothing like this has ever happened to a major industrial nation to my knowledge – not even during the 1929 – 1933 Great Contraction. (my emphasis)

3) The trade weighted yen is by far the strongest currency in the world. Japan is losing competitiveness fast. Given the lags in trade matters will get worse.

4) The insane trader community continues to push the yen up as a safe haven. It is all so detached from reality I suppose they could take it higher. (my emphasis)

I have been writing about an Asian black hole for almost two months now. I have been crying from the rooftops about an emerging depression in Japan. It has been as though a neutron bomb had gone off in the world. There was no one who seemed to notice, no one who seemed to listen.

Every week it gets worse and worse and worse. Today it was Japan....

THERE HAS NEVER BEEN DATA THIS BAD FOR ANY MAJOR ECONOMY – EVEN IN THE GREAT DEPRESSION. December industrial production came in down 9.6%, worse than the METI forecast. It is now down almost 21% year over year. METI forecasts a further 4.7% decline in February. The inventory to production ratio soared again. Maybe METI will be correct. (Veneroso’s emphasis)

If it is, Japan industrial production will have fallen 28% (non annualized) in four months. It will have fallen by a third in about a year. Nothing in the history of major nations compares. A 28% decline in four months would be more than half of the entire decline in U.S. industrial production over the 3 years and nine months of the U.S. Great Depression.

It would be a greater decline in four months than in any 12 month period in the Great Depression in the U.S. We are literally looking at the unimaginable. (I am attaching the U.S. industrial production index from the Great Depression for comparison).

IT’S A DEPRESSION IN JAPAN – ALREADY – PURE AND SIMPLE…

Financial markets have only one rationale in economic theory: to sift through all of the fundamental information that has a bearing on prospective returns to investments and thereby establish the set of “right” prices that will lead to an optimal allocation of real resources. Because of uncertainty and imperfect information, an optimum allocation will never be reached, but a second best allocation can. There is no other “social” rationale for financial markets.

When financial markets become nothing other than a casino, as they had during the bubble period, and market participants flee fundamentals for the witchcraft of technical analysis and other divinings of market dynamics, market participants will send prices flying about in ways that have nothing to do with prospective returns to real investments. The result will be a serious misallocation of real resources.

When bubblized markets go from a mere speculative casino to a casino in which pivotal players are driven only by the pursuit of short-run fee income by hook or by crook, you can get a more willful proliferation of “false” prices and an even worse misallocation of resources.

This is what has happened over the last ten years. The result is what economic theory says it should be: today’s global financial, economic, and social catastrophe. The ruling maxim in such a regime seems to be that market participants will push prices to the point where they do the maximum financial, economic and social damage. I believe that, despite the massive losses to market participants that such behavior has now brought them, their behavior has not changed. Half a generation is enough to breed a cohort among market participants that knows of no other way. This cohort has been hurt and has had its wings clipped, but the markets have become commensurately less liquid. This cohort still runs the show.

Let us now apply this to the Japanese yen. According to the most recent economic data the land of the rising sun apparently risks falling off the face of the earth. Nonetheless, the Japanese yen soars. We hear the ludicrous mantra from all the investment banks and all of their speculator clients that the yen is a safe haven amidst the global chaos.

To my mind the real reason why the yen soars is because it soars. Except for a brief interlude in the mid 1990s the Japanese yen has been bounded on the upside by a ROUND NUMBER – 100 YEN TO THE DOLLAR. It bumped against the ceiling time and again. In recent months the unwinding of massive yen financed carry trades caused a powerful, though transitory, impetus on the part of yen debtors to panic purchase yen. This impetus broke the yen through its magic barrier of 100. Since everyone now ignores fundamentals and only looks at the witchcraft of charts and technical tools they now all have the next technical objective of 79 yen to the dollar on the brain. That was the spike high in the yen in that brief mid 1990s foray above the great ROUND NUMBER of 100. In my judgment it is this chart objective on the brain that explains yen strength today now that most of the panic buying by yen carry traders has abated…

The yen is strengthening massively against currencies all over. On a trade weighted basis, it is by far the strongest currency on the planet. There are long lags between changes in currencies, exchange rates and trade. The recent take off in the yen is not yet fully reflected in Japanese exports. The lags are too long. The weakness we are seeing in Japanese exports today is in large part derived from aggregate demand weakness from its trading partners. It is the result of an earlier appreciation in the yen for perhaps 120 yen to the dollar to 110 to the dollar or 100 to the dollar. And perhaps, most importantly, it is the result of a secular trend in which its lower wage neighbors in Asia are making inroads – big inroads – into the global markets which it has traditionally dominated as an exporter.

When the long lags between the yen exchange rate change and trade and industrial production fully run their course the land of the rising sun may fall off the face of the earth. And with it will fall all the market participants who refuse to look at fundamentals and chase chart witchcraft and ephemeral market dynamics who have been the big bulls engineering that yen exchange rate that will maximally undermine the markets, economy, and social fabric of Japan.” (my emphasis, again)

Bill, Japanese society has historically exhibited great stability within rigid social structures. However, whenever pressure has built up to the point that change was forced, that change has been of an extreme and unpredictable nature. How close are we to the threshold? Chuck Cohen told me he saw a report that crime by the elderly, not against them, is up 400% in Japan. If even the elders of that nation are being forced into crime to survive, we may not be far off. The Forex traders are playing with a kind of fire they have little understanding of, a force that has the potential to knock the world’s financial and, maybe even, political systems right off their foundations.

Best wishes,
Peter R.

ttp://www.nakedcapitalism.com/search?updated- max=2009-02-02T16%3A24%3A00-05%3A00&max- results=5