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Has the Next Crisis Begun?
05/07/2013 9:00 am EST
The Bank of Japan's latest economy-saving efforts seem likely to trigger another Asian currency crunch, says Anthony Mirhaydari of MSN Money.
The real wild card that could set off a wave of selling pressure is something nobody is talking about—the specter of a new currency crisis in Asia.
It's worth remembering that the market's recent surge has been driven, almost exclusively, by the Bank of Japan's decision last month to double its monetary base over the next two years, in an effort to restore some vigor to a deeply indebted, deflation-plagued Japanese economy.
This extreme monetary policy easing—going all-in on the same strategy being used by the Federal Reserve, the Bank of England, and, to a lesser extent, the European Central Bank—has crushed the Japanese yen and made it attractive as a funding currency for hedge fund "carry trades."
Carry trades are simply two-sided trades. First, you sell yen "short" in the futures market. Then, with the cash raised, you buy things like Spanish or Italian bonds (denominated in euros) or US stocks (denominated in dollars). The trade pays when the yen falls, the assets you bought rise, or the currencies your assets are denominated in rise against the yen.
Japan's endgame isn't pretty. Let's not sugarcoat it: The BOJ's efforts are a last-ditch Hail Mary attempt.
Japan's ratio of debt to gross domestic product stands at 245%—the highest in the developed world—and more than twice the size of US relative indebtedness. And like America, Japan's fiscal woes are being fueled mainly by an aging population and the welfare entitlements promised to seniors.
The country is already in fiscal quicksand. Tax revenues currently don't even cover the government's required expenditures on social security programs, education, and debt service. And that's with ten-year government bond yields at just 0.59%.
If the BOJ achieves its target of boosting inflation to 2%, bond yields and interest expense would more than quadruple, effectively bankrupting Japan and forcing the BOJ to monetize government debt outright. The result would be a rout in the yen and turbulence in the foreign exchange markets.
As the Dow has surged to new highs, Chinese stocks have been crushed as China's currency, the renminbi, has soared relative to the dollar—damaging China's export competitiveness, which is critical to Chinese companies.
The iShares FTSE China 25 (FXI) ETF is down 14% from its January high. China's Flash PMI manufacturing activity report fell to 50.5 in April versus the 51.5 expected. South Korea has also been hit, with the iShares South Korea Capped Index (EWY) down 14% from its January high.
Société Générale strategist Albert Edwards is concerned about another 1997-style Asian currency crisis, this time focused on China. Growth in Capital Economics' China Activity Proxy—using indicators such as passenger transport volumes and trade volumes to track Chinese growth without relying on manipulated official GDP numbers—has plunged to levels not seen since the depths of the 2008 financial crisis. The decline is being driven by a fall in construction activity and a rise in developers' inventories—both credit-dependent areas.
All of this risks throwing many of the dynamics that have supported the global economy over the past decade-and-a-half into reverse—with unknowable social and political consequences for China. The other big question? With China out, the Eurozone still a mess, and Japan scraping the bottom, can the US economy grow enough keep the world out of a new recession?
I don't think it can. Not with taxes rising. Not with new health-care regulations. Not with job growth stalling. Not with consumers as tapped out as they are.
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