Issue No. 12, July 1998
Posted 19.VII.1998CONTENTS
So, are we at a turning point, or is this only a false dawn ? That is the question for this month's Issue.
The event that, at least chronologically, marked the beginning of this new wave of optimism was a joint American-Japanese intervention in the forex market on Wednesday June 17. This is convenient because it means we can look at what is going on by starting from the three 'pointers' [LINK] that were the conclusions I drew from the global trends assessment in the last Issue [LINK] Skeptical Investor No. 11. June 14 1998). Because the following is based on the same overall assessment, it may be a good idea for readers to review the June Issue before continuing.
The anticipated international intervention in the Yen:USD exchange rate happened very quickly - on June 17 - and must have already been planned and agreed in principle between the USA and Japan before that weekend (June 13/14). In a joint action starting at 0800 EDT (12.00 GMT) an estimated US$2 bn were sold for Yen, pushing it up by nearly 5% against the dollar within hours. This big response shows that the intervention took a lot of currency traders completely off guard, which of course is exactly what it was intended to do. But apparently not all:the Yen had already climbed from its low of 146.75 (June 16) to 143.22 before 0800 EDT June 17, so someone was already being cautious.
The reason for the surprise - and for the strong effect of the action -was not so much that it was a joint effort, but that the USA was a participant at all. The credibility of unilateral action by the Bank of Japan had been damaged a couple of months earlier when it spent what is estimated to be ten times as much - US$20 bn - in what proved to be ineffective support of the Yen. Few currency traders believed they had much fear from further BoJ intervention. But the participation of the USA ... this was something new, and a shock to many. This was the first time since the"reverse Plaza Accord" that the United States had intervened directly in the foreign exchange markets in support of the Japanese currency unit. Further, US Treasury Secretary Rubin has consistently, and sucessfully, followed an unambiguous "very strong" dollar policy so an action that involved reducing the value of the USD was at odds with all recent precedent.
Were this to represent a fundamental shift in policy, it would be the most internationally significant such shift in a decade. But it is extremely unlikely that it does signal any change of direction, and I do not think many analysts would disagree. The United States embarked upon it very reluctantly indeed, and only because things were spinning out of control (the Yen was in danger of plummeting) and because they were backed into a corner by the Chinese who made it very clear indeed that if something was not done they were going to devalue their currency.
What it has done however is, for now at least, to stabilize the Yen by putting a cap on it of perhaps 145 Yen to the dollar, or thereabouts. Currency traders will no doubt now get very nervous if that level is approached. And it stopped a possible slide into a new round of severe currency chaos: thus buying some time during which, those concerned hope, the global economy can be repaired. What it did not do though is change anything fundamental. The underlying reasons for the weakening Yen and the surging dollar remain as they were. The United States still has a strong dollar policy and, at about 140, the Yen is still internationally weak. Thus the capital flows that have distorted the global markets may be expected to continue as before.
(It has also demonstrated that the People's Republic of China now has enormous economic power, and prestige, throughout Asia. Expect China to play an increasingly important role from now on.)
The Canadian unit is vulnerable because of the nation's economic policies exacerbated by falling commodity prices due to the Asian recession(commodity exports are important to Canada). The slide against the US currency paused at the end of last week on the renewed optimism in Asia, and because the US dollar itself weakened somewhat, but many analysts have been saying they expect it to continue.
POINTER: The danger is worse than that: the Canadian dollar may now be vulnerable to a massive short-selling attack by the hedge funds.
Further, those Canadian politicians who have been telling the populace that the decline in the value of the currency hardly matters to them except when they go on vacation to the United States or Europe are either lying, incompetent or plain stupid.
In line with all that I have said above, I do not see either as being evidence of a change in the trends, but merely temporary adjustments directly related to the increased (but, in my view largely unwarranted) optimism elsewhere. Bond yields are being driven down because now almost everyone - optimists and pessimists alike - sees deflation, or at least continuing disinflation, ahead. The New Era optimists expect continuing healthy disinflation, whilst those who (including myself) interpret the US stock market as a bubble that is going to burst see the possibility of a deflationary recession. There is also no evidence of any change in the US "very strong" dollar policy, and little that I can see that leads me to expect any substantive reversal of the flow of international capital into US dollar assets for the time being.
However, growth in the US money supply has not as I had hoped slowed, so this raises doubts over the medium-term outlook. Due to the need to cover the dramatic events of the last month in this Issue I have deferred my plan to review the US markets until the next Issue.
For now though, I will leave you with this. The United States has a GDP of$8 trillion. The total capitalisation of its stock markets is now $11trillion. An overall 50% decline in share prices at this stage would be a loss of perceived wealth equal to almost 69% of annual GDP.