Sunday, November 12, 2006

Financial Shell Games

EUR/USD 1.2840 Hi 1.2900 Low 1.2826
USD/JPY 117.59 Hi 117.17 Low 117.92
AUD/USD 0.7676 Hi 0.7660 Low 0.7697
EUR/JPY 150.98 Hi 150.26 Low 151.46

There is an entire Doomsday Crowd waiting for cracks to appear in the USA and there is no shortage of pundits who suggest that everything in the USA will all end in tears very soon. Certainly economic management in the USA has been poor and it shows. We could line up all the data, from Construction Spending to Retails Sales and shake our heads about the poor financial position of that Great Consumer of Last Resort which America has come to represent to the rest of the world. Quite. But there are problems which are just as severe and entrenched in other parts of the world which are being entirely ignored. Indeed MOST financial newspapers and professional forecasters are either blithely nonchalant about the looming crisis or even more blithely bullish.

Think of a country where Household Debt to Income ratios are sitting somewhere around 150% and Gross Government Debt to GDP is currently sitting at around 170% with no sign of a coherent plan to address the problem.

Think of a country where the Central Bank has flooded the market with liquidity for the better part of a decade in the mad hope that simply printing money would solve all their problems. And PUNDITLAND has quietly endorsed this policy approach. Cheered even.

There have been no comparisons made with the doomed monetary policy of the Weimar Republic and the assumption has been widely accepted that fiddling with interest rates and printing money was the right approach to a domestic debt crisis brought on by excessively cheap money, which at the time was seen to be an appropriate response to the sharp adjustment in exchange rates imposed on Japan via the Plaza Accord. It's some kind of crazy loop.

In hindsight it seems so entirely crazy that printing money could be seen to be an appropriate response to real economic distress that it’s a wonder that anyone bought into the idea. But they did: in droves. In an era of new paradigms Japan was the ultimate new paradigm. First you fiddle with the exchange rate, then with interest rates, then everyone goes broke then you fiddle with interest rates some more and then, as a last resort, you crank up the printing presses and print money as fast as possible.

What’s more the story went out a couple of years ago that an economic recovery was in the offing in Japan and Offshore Funds rushed into the Stock Market. The stock market rallied over 2005 and the bullish pundits rejoiced. This year the major Stock Market Index is flat as a pancake and the economic data is starting to look very uninspiring indeed.

Japanese Household Spending
Japanese GDP
Japanese Profits and Stocks Disappoint

Japanese Machinery Orders Fall

But there seems to have been no adjustment in PUNDITLAND. Still nary a bearish call out there with regard to Japan.

What’s the deal? Does Mercantilistic Theory has everyone in thrall? As long as the Japanese International Trade Account is in Surplus then everything is just fine? The Japanese Trade Account is indeed one of the world's greatest economic success stories. But the Japanese capacity for financial management seems to be slightly less than brilliant. While the Japanese are diligently working away producing stuff to sell to the rest of the world the fruits of their industry seem to have been recklessly squandered. Or rather recycled into U.S. Treasuries. Which comes pretty much to the same thing.

It seems that Japan might have painted itself into something of a financial corner. So now we really get to test these new paradigms. What happens next? I have no idea. But if cracks start to appear in the Nikkei, as looks likely, it is unlikely that the U.S. Stock Market will keep rocketing skyward without a care in the world. The Japanese are, after all, providing the U.S. with what is essentially free money and they have been doing that for some time. But as the financial shell game winds up things could start to be just a bit tricky.

The Doomsday Crowd, bless their souls, should switch their gaze eastward. We have lots more data out of Japan this week. And the Nikkei is shaky. What this means for the YEN is uncertain, though more ugly economic noises and an exodus of Foreign Investors from the Japanese Stock Market are unlikely to provide room for a rally.

OIL 59.59
GOLD 629.50

GOLD is holding on. Should financial market shakes be added to all the other uncertainties out there, including Central Bank Diversification, then there is scope for more gains in the price of GOLD.

The OIL story is slightly more complicated. We have a potential global economic slowdown looming, rather closely, and the Republicans just got a good kicking which means that the situation in the Middle East is far from clear but there is potential, just potential, for LESS violence, which wouldn't be good for the price of OIL. It's a bit early to take a clear position on this one. So sit on sidelines and wait to see what gives.

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