Rock Theories - Plunge Caused by Yen Rally!  Part 2

Part 2


"To stand pat on monetary policy for a long period of time is not a prudent strategy, since the acceleration of economic activity may in the future come to require a large adjustment in the policy rate, causing unnecessary swings in economic activity and prices," said BoJ member Kiyohiko Nishimura on July 3rd. However, at a subsequent meeting on July 12, only BoJ member Atsushi Mizuno voted for a rate increase.

"It is desirable for policy rates to naturally converge to levels that would help minimize destabilizing risks to the economy. Side effects of keeping low interest rates regardless of economic conditions could weaken the yen and may increase protectionism among Japan's trading partners. It could also cause distortions in global asset prices by speeding up capital outflows from Japan," Mizuno warned.

Tokyo's financial warlords, working in a close coordination with the US Treasury's Plunge Protection Team (PPT), have been skillful in guiding the dollar higher for most of this year.

But Tokyo and the PPT were caught off guard by Iran's Ayatollah, when he demanded on July 14th, that Japanese oil refiners pay for Iranian crude in yen, instead of US dollars, starting in September.

The Ayatollah wants to be paid in Euros and yen for Iran's $54 billion of annual oil exports. That's just a drop in the bucket in the $2.9 trillion per day foreign exchange market. But since Nippon Oil agreed to pay for Iranian oil imports in yen, the US dollar has tumbled by 3.5-yen to as low as 119.10-yen.

Japan imported about 323,000 barrels per day of crude oil from Iran last year, or about 11% of Japan's total oil imports, in 2006. The National Iranian Oil Company is also trying to avoid a possible seizure of its assets by the US government amid tensions over its nuclear weapons program. China buys 15% of Iran's oil exports and has been paying in Euros since December. The Ayatollah's advisers might be skilful foreign currency traders, turning bearish on the dollar at 122.50-yen.

At the June 15th BoJ meeting, some members noted a recent 0.25% rise in 10-year JGB yields to 2%, saying it was important to find out whether it was due to a favorable view on the economy or higher inflation expectations. Bank of Japan chief Toshihiko Fukui said the central bank needs to keep a close eye on recent rises in long-term rates and how they could affect Japan's economic outlook.

"The recent movements in long-term rates are a relatively new phenomenon so we need to watch them closely. It would be very problematic if the rise in bond yields signaled that market players are cautious about rising inflationary expectations," he said. Yet that's exactly what's happening, with crude oil hitting a record 9,400-yen per barrel in Tokyo. Would Japan's financial warlords permit a stronger yen to keep oil and raw material import costs from exploding higher?

Perhaps the dollar /yen exchange rate is simply catching up with the greenback's big losses against every other currency around the globe. The US$ has been tracking the slide in the riskiest segment of the US sub-prime mortgage market, the ABX, BBB-, fell to just 39 cents on the dollar, and could lead to big losses for US banks and brokerage firms, and tighten lending standards in the housing market. With a glut unsold US homes at 8.8 months, and homebuilder sentiment at its lowest since January 1991, the US dollar has been on the skids all year.

With the Dollar Index teetering on the key psychological 80-level, the US Treasury's Plunge Protection Team sprung into action on July 23, with "Jawboning" exercises. "There has been a very significant housing correction. I think we're at or near a bottom there," US Treasury chief Henry Paulson said on CNBC. "I don't deny there's a problem with sub-prime mortgages but it's quite containable. The economy is very, very healthy, despite the problems in the sub-prime mortgage lending sector.

"On July 20th St Louis Fed chief William Poole, tried to brainwash his audience, with a "Don't worry, be Happy" speech. "The US sub-prime mortgage problems probably have a ways to go, but unless the pressure becomes much more severe, the problems would not impact consumer spending or credit quality more generally."

But three days later, on July 23rd, the Dow Jones Industrials lost 236-points, partly due to the unwinding of "yen carry" trades and a slew of disappointing earnings from Caterpillar, American Express, Home Depot, Countrywide Financial, USG, US Steel,  among others, in a market priced for perfection. On July 25th, US PPT chief Paulson was hosting a conference on US corporate taxation, while the dollar was skidding towards 119-yen, and the Dow Jones Industrials were plunging 320-points lower in a panic towards the 13,460 area.

Harvard University Professor Martin Feldstein told the audience that "as long as the American dollar is greatly overvalued relative to other currencies, it's going to be hard for American products to get their share in other markets," perhaps referring to the manipulated Chinese yuan and Japanese yen. "Marty, I'm a strong dollar man," Paulson replied, fearing the possibility of a brutal unwinding of "yen carry" trades, and the blow-up of the PPT's Ponzi schemes arranged with Beijing and Tokyo. 

But what about the surge in crude oil prices to $77 per barrel, up 20% from just two months ago?Should the markets be worried about the spiraling cost of energy that could sap household disposable income and crimp business profits?

In his speech on July 24th St Louis Fed chief William Poole tried to brainwash the public with a sense of complacency. "There are certainly strains from the high price of energy, however, there is no energy crisis and households and firms are adjusting in a sensible way to price increases. Oil price increases over the past several years are, in percentage terms, roughly comparable to the 1970's episodes, but overall inflation has remained relatively contained."

"The impact has been real, but the magnitude is small enough that prices increases have not disrupted the normal processes of economic growth. In my judgment, markets will continue to handle energy problems well and the future for the US economy is bright. Recent attention paid to the negative impact of higher gasoline prices on the consumer energy prices has been overstated," Poole argued.

Is gold a safe haven from the brutal stock market shakeout? The US M3 money supply is expanding at a 13% annualized rate, its fastest in 30-years, the US dollar is plunging to its lowest levels in decades, and crude oil prices are soaring to record highs. Most logical folks would probably agree these signals are forecasting higher inflation, and bullish for gold, irrespective of the Fed's contortionism.

But we have seen this movie before, and during previous periods of panic stricken sell-offs in stock markets, gold has been swept lower by the contagion. If the Dow Jones Industrials are starting to price in a US economic recession however, then gold should outperform the DJI-30 index, no matter which way the markets move. 

Under Paulson's tenure at the US Treasury, stock market bulls have always been able to rely on their "Plunge Protection Insurance" policies, to rescue their portfolios from nasty corrections. But as the stock markets climb to higher and higher levels, the cost of the Plunge Protection Insurance premiums is also going higher, as mushrooming money supply growth guarantees greater volatility in the markets.

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Gary Dorsch