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- The Yen has been falling in the face of high debt and inflation
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- Short term rallies attributable to FX BOJ intervention of as much as $37 billion
By Investing Pioneer
October 24, 2022 – Investing Pioneer – 3:18 PM EDT
The talk of the town these past few days has been the Japanese Yen. In short, it’s plummeting.
In response, on September 22nd, the BOJ intervened to support their currency. By now, it seems like they’re doing it every other day.
Chaos in the Forex markets has started, and it’s going to get much worse (eventually).
Japan is not the only country that’s going to have problems.
Lets look at why this happening, and what it means for the global economy going forward. Hint: it’s not good.
Central banks, including the Bank of Japan, Bank of England, the Federal Reserve, you name it, are (or will be) faced with a choice: weaken their currencies to save the bond market or vice versa.
From the onset, once it became clear this would be a problem, the decision all central banks would eventually make was obvious. Save bonds, weakening respective currencies in the process.
That presumption is now starting to be validated, starting with Japan. With the effects of policy now being seen (a collapsing Yen), they’re intervening to slow the crash.
Some estimates claim the intervention amounts to tens of billions of dollars utilized so far.
If they raised rates significantly, the interest on their debt would be so large, inflation would go exponential. Thus, Japan’s determination to keep interest rates low is plunging the Yen to levels not seen in decades (relative to USD).
With a debt-to-GDP ratio of 260%, it only makes sense the clear effects of collapse start with the Japanese Yen first. Meaning, it can serve as a canary in the coal mine. Albeit, with a relatively late predictive capacity.
When interest rates are kept low and inflation is high, a question arises. Who would want to hold that? Could there possibly be high demand? The answer would be no. Not natural demand at least. Artificial demand on the other hand…
Because of this setup, the BOJ must ramp up intervention (buying) in the bond markets to keep rates low. Remember, if rates rise, interest payments on their debt quickly spiral out of control, and total economic calamity ensues.
Considering these conditions, one would expect the Bank of Japan is a major holder of bonds.
Bond Ownership Nears 70%
-Bloomberg
Indeed, they are. This should not be the case in a stable system. There is too much debt, and it shows.
The byproduct of this bond-buying program is a weakening Yen as the USD strengthens (relative to other currencies) because US treasury rates are rising.
That said, all currencies are falling, including the dollar. Do not confuse the strength of the dollar with a rise. The dollar is simply falling slower than other currencies.
USD to JPY (Japanese Yen):
In response to the sharp weakness in the Yen, Japan’s Finance Minister, Sunichi Suzuki, said this…
“Excessive FX volatility caused by speculative trading is undesirable.”
And that brings us to the main theme of this article – It’s not the speculators. At least, it’s certainly not the root of the problem.
To understand this situation, we’re going to have a look at monetary and economic policy over the past 50 years.
There are two fundamental modern monetary systems. One in which the currency is backed by a mostly immutable money, and one that is not (some call it fiat).
The former allows for stability (though this is not always the case… quite the contrary), and if not impugned upon, limits the potential for inflation to take a foothold in the economy. That said, the latter is not inherently bad, and there are limitations to both systems.
The Nixon Shock
By 1971, the Bretton Woods monetary system had been in place for 27 years (though not fully implemented until 1958). It allowed the convertibility of currency to gold, thus making the currency gold-backed.
On August 15th, 1971, Nixon announced the end of the Bretton Woods Gold Standard by halting the convertibility of USD to gold.
“We must protect the dollar from the attacks of international money speculators.”
-President Nixon, 1971
Sound familiar?
“Excessive FX volatility caused by speculative trading is undesirable.”
-Sunichi Suzuki
Erroneous monetary policy that compounded over the years, both in Nixon’s time and today, eventually lead to instability, an arch-nemesis of governments and central banks. Accordingly, they reference “the speculators”.
The culmination of governmental and monetary policy over the past 50 years has led us to this unfortunate point. Not just for Japan, but the entire financial system.
Simply, Japan is worst off with regard to debt excesses, and consequently, in its position of weakness, will experience hardship earlier, as we enter this environment that will prove un-survivable for the monetary and economic system in its current state.
On a positive note, on the back end of the collapse, economic growth will return.
In a market-determined economy, supply and demand are sufficiently regulated (supply and demand principles apply to debt, bonds, etc., and have an effect on the currency). When central banks go too far, supply and demand are distorted to the extent that eventually, reality must catch up.
Accordingly, extreme inflation in the coming years is forecasted.
