[Marxism] "Emerging markets" teeter, yen-dollar rise marks popping currency bubble

[Fred Feldman]

The following articles were submitted to the Washington State-based Snow
News antiwar list by Prof. Mark Jensen. He is the author of the introductory
comments that follow.

ANALYSIS: It turns out world is on yen standard -- Mysteries of the 'yen
carry trade' explained

[It's no longer the global financial crisis, it's "a real economy crisis,"
the *Financial Times* said late Friday: "the problem is runs on
everything."[1] -- 

"The global economy is stalling and even low
expectations are being dashed. Investors are now loath to hold anything."
-- The British daily emphasized the role that the collapse of the yen
carry trade is having on the global situation. -- 

This matter is so
arcane that it is hard to imagine it being explained to the American
public in U.S. mainstream media, but the *Financial Times* is making an
effort. -- 

Briefly, because borrowing in Japan, where interest rates
have long been low, has been inexpensive, many investors have used this to
finance the purchase of high-yielding assets. -- This has meant an
abundance of yen on currency markets, keeping Japan's currency weak. -- 

Now that this borrowing is drying up, so is the supply of yen, and as a
result the yen is strengthening, as the *Financial Times* described in a
separate piece published late Friday and updated Saturday.[2] --

John Authers, financial analyst at the *Financial Times*, argued that the
"yen carry trade" was a bubble that has just burst, causing new instability
in the global economy: "People have talked about the 'yen carry trade' for
years," he wrote early Saturday. -- "Those of a bearish persuasion had
warned it was one of the greatest bubbles left to burst. Many others,
judging by my e-mail inbox, found their warnings farfetched. But events
last week suggest the bears were right."[3] -- 

Statistics corroborate
this view: "Since 2004, the correlation between the U.S. stock market and
the euro-yen exchange rate has been total." -- Because the difference in
interest rates was influencing the demand for currencies and thus exchange
rates, "[m]ore or less all currencies that paid a high yield (virtually
all currencies in the emerging markets, and even the euro and the British
pound) were overvalued," Authers explained. 

"There was a general
undervaluation of low-yielding currencies such as the Swiss franc and,
recently, the dollar." -- According to this view, the bursting of the
carry trade bubble "removes the last source of cheap money and forces yet
more selling of other assets." -- 

All this is especially important for
poorer nations, because "the currency crash sharply raises the risk that
emerging market nations could default. It inflicts losses on
multinationals in the emerging markets and makes planning for all
multinationals virtually impossible." -- 

What is happening is altogether
without precedent, Authers pointed out: "[I]n the past week,
high-yielding currencies are behaving exactly like an asset class in a
bubble. Such sharp devaluations in the past were because government
attempts to peg prices broke down. There is no precedent for currency
moves on the scale of the past week's in a free-floating environment." --

It turns out, it seems, that "the world is on a yen standard." -- Seen
from this perspective, "history looks different. In yen terms, the
FTSE-100 is its lowest in 13 years, and the S&P 500 is at a 12-year low. 
The S&P is down 57 per cent from its peak, on the yen standard. The FTSE
is down by two-thirds. --  

Viewing the world in yen terms should have
made obvious that equities were in an unsustainable bubble. From a low in
1994, the S&P quadrupled in yen terms before peaking. In the past three
years, Brazil, the most popular emerging market recently, gained 267 per
cent and then lost every yen of it. -- 

With no precedents, it is hard to
see where a general currency sell-off could end. But forex is behaving
like a crashing stock market, and stock markets tend only to find a level
once they have overshot and become too cheap. For many in the emerging
markets, that could be ruinous." --Mark]

http://www.ufppc.org/content/view/7997/

1.

Comment & analysis

Editorial comment

LOW EXPECTATIONS COULD GET LOWER

Financial Times (London)
October 24, 2008

http://www.ft.com/cms/s/0/229a853c-a1fb-11dd-a32f-000077b07658.html


When there was just a financial crisis, the problem was runs on banks. 
Now there is a real economy crisis, and the problem is runs on everything.
The global economy is stalling and even low expectations are being
dashed. Investors are now loath to hold anything. Currency trauma in
Europe mean that part of the crisis’ real legacy may be a bigger euro
area.

Economic activity across the world, everywhere from the U.S. to China, has
fallen back. In the U.K., data released this week showed that gross
domestic product fell by 0.5 per cent in the third quarter. This fall was
much bigger than anticipated -- but worse may follow. By any sensible
definition, the U.K. is already in a recession. In the eurozone, recent
surveys of puchasing managers suggest that the recession will be quite
severe.

The fall in global consumption is evident in the oil price. Oil was near
$100 a barrel at the start of October. A rapid fall to below $70 this
week prompted OPEC, the oil producers’ cartel, to announce a cut in
production of 1.5m barrels a day. But global demand for oil is falling
even faster; the price has since slumped to nearly $60 a barrel.

Stock markets, which had been rather slow to respond to events in the past
year, are catching up. Weaker growth means earnings estimates get
downgraded. Spooked investors, who have already suffered a lot, are
cutting their losses. Investors want safety; the only money market funds
attracting savers are those investing exclusively in U.S. Treasuries. On
Friday, the FTSE 100 fell 5 per cent and the Hang Seng dropped 8 per cent.
These declines are being exacerbated by funds which are selling off
assets as they deleverage. Many funds are also raising cash in
preparation for withdrawals by retail and wholesale customers.

The slowdown is also hitting foreign exchange markets, which are expecting
large interest rate cuts in the U.K. and the eurozone. Investors do not
want to hold sterling or euros, preferring dollars and yen whose interest
rates cannot fall much further because they are already so low.

Meanwhile. the yen is strengthening because of the unwinding yen carry
trade. This is the practice of borrowing in Japan -- where interest rates
are low -- and buying high-yielding assets elsewhere. The carry trade has
long made lots of yen available in exchange for other currencies, keeping
the Japanese currency weak. As the world slows and institutions unwind
positions, the carry trade is drying up and Japan will face this recession
with a strong yen. This will pose a problem for Japan’s export-heavy
economy.

Small countries, meanwhile, are struggling to defend their currencies as
investors flee to bigger, safer economies. Hungary, which has propped up
the forint by raising interest rates by three percentage points to 11.5
per cent, should find it easier to stomach joining the euro. Denmark on
Friday raised rates by 0.5 percentage points to prevent the krone from
slipping against the euro. Many Danes must now wish that they had joined
the European currency union when they last had the chance.

2.

Markets

Currencies

YEN SURGES AS PANIC GRIPS MARKET
By Peter Garnham

Financial Times (London)
October 24, 2008 (updated Oct. 25)

http://www.ft.com/cms/s/0/67e78a7c-a1b0-11dd-a32f-000077b07658.html


The yen surged higher this week, hitting 13-year highs against the dollar
and pound, and jumping to a six-year peak against the euro as panic
gripped global markets and forced investors to abandon risky positions.

Traders said investors around the world were being forced to liquidate
positions in equities, commodities, and higher-yielding currencies amid
growing evidence that the global economy was heading for a sharp downturn.

This rise in risk aversion benefited the low-yielding yen as, prior to the
crisis, it had been widely sold to finance the buying of higher-yielding,
riskier assets.

Lee Hardman, of Bank of Tokyo-Mitsubishi UFJ, said the yen’s gains
reflected the prevalence of risk aversion, recession, and repatriation.

He added that the yen continued to derive support from the looming
prospect of a long and deep global recession that undermines the appetite
for investors to re-establish riskier positions.

“In fact, given current market conditions, it is more likely that
investors will continue to deleverage for the foreseeable future,
prompting the unwinding of long risky asset positions funded through short
yen positions,” said Mr. Hardman.

The precipitous declines in the Japanese equities were likely to fuel yen
supportive repatriation flows from Japanese investors. “It has created a
perfect storm scenario, which has lead to exceptional yen gains in both
magnitude and pace,” added Mr. Hardman.

David Deddouche, of Société Générale, said hedging flows on structured
currency products called power reverse dual currency bonds had helped push
the yen massively higher.

In recent years, these instruments have been popular with Japanese
investors who want higher yields and who are willing to bet that the yen
will depreciate against the currency linked to the bond -- popularly U.S.
or Australian dollars.

Mr. Deddouche said that, as the yen surged higher through Y95 against the
dollar, option structures kicked in that forced market makers
to buy huge amounts of yen.

For the week, the yen rose 8 per cent to Y93.44 against the dollar,
climbed 12.7 per cent to Y118.94 against the euro and gained 16.4
per cent to Y147.11 against the pound.

Higher-yielding currencies were also hit hard against the yen, with the
Australian dollar on Friday putting in its worst one-day performance for
32 years. Over the week, the yen rose 18.1 per cent to Y57.75 against the
Australian dollar and climbed 16.5 per cent to Y52.15 against the New
Zealand dollar.

The U.S. dollar, which like the yen has been used as a funding currency,
surged higher as investors unwound positions and returned to cash.

The dollar rose 9 per cent to a six-year high of $1.5751 against the pound
on the week, climbed 5.2 per cent to a two-year peak of $1.2721 against
the euro and gained 7.8 per cent to C$1.2737 against the Canadian dollar.

Sterling hit a record low against the euro, as figures on Friday showed
that the U.K. economy contracted for the first time since 1992.

The pound, which was hit in the week as the Bank of England warned that
the U.K. economy had entered a recession, dropped 4.2 per cent to £0.8074
against the euro on the week.

Emerging markets were also hit. Over the week, the Korean won fell 11.8
per cent to Won1,425.50 against the dollar, while the Hungarian forint
lost 9.2 per cent to Ft217.37.

3.

Companies

Financial services

CHAOS CARRIES A RISK FOR EMERGING MARKETS
By John Authers

Financial Times (London)
October 25, 2008

http://www.ft.com/cms/s/0/e50e42fc-a22d-11dd-a32f-000077b07658.html


Chaos theory holds that a butterfly flapping its wings in Tokyo could
cause a tornado in Texas. The analogy is relevant for investors. There
is chaos in the markets, with financial hurricanes blowing at full force
worldwide.

Yesterday's savage selling forced Korea's stock market to close early and
led to the biggest daily fall for the pound against the dollar. It
follows events, many in Tokyo, that seem as inconsequential as the
flapping of a butterfly wing.

People have talked about the "yen carry trade" for years. Those of a
bearish persuasion had warned it was one of the greatest bubbles left to
burst. Many others, judging by my e-mail inbox, found their warnings
farfetched. But events last week suggest the bears were right. Their
theory deserves re-examination.

Since the 1990s, Japanese interest rates have been minuscule as Japan
fights deflation. That opens the chance to borrow in yen, or sell the yen
short, and park in other currencies that pay a higher yield, or use the
cheap funds to make risky investments elsewhere. Traders doing this
pocket the difference, or "carry."

It is easy money -- unless the yen rises sharply, thus raising the cost of
the debt.

So, when uncertainty increases, the yen tends to strengthen as investors
take their profits in the carry trade and sell stocks.

Since 2004, the correlation between the U.S. stock market and the euro-yen
exchange rate has been total.

There is argument about who was making the trade. Some said Japanese
retail investors (known as Mrs. Watanabe) who recognized that, with a weak
yen, the best returns came from investing overseas, selling the yen in the
process. Others reckoned it was one of many ways in which hedge fund
managers found cheap leverage.

Both now seem to be correct. The carry trade was also broader than many
appeared to realize. More or less all currencies that paid a high yield
(virtually all currencies in the emerging markets, and even the euro and
the British pound) were overvalued. There was a general undervaluation of
low-yielding currencies such as the Swiss franc and, recently, the dollar.

Several bubbles have already burst. U.S. housing was followed by credit,
commodities and then stocks. These were interconnected. Deprived of
cheap credit and facing losses, investors (led by hedge funds) were forced
to sell whatever investments were still showing a profit.

For many investors, that involves buying dollars as non-American
investments are sold. Japanese retail investors brought their money home.
Hedge funds repaid debts in yen.

As a result, the carry trade bubble has burst. That removes the last
source of cheap money and forces yet more selling of other assets.

It is a self-reinforcing process. George Soros,
(http://www.ufppc.org/content/view/7964/)
the billionaire hedge fund
manager, labels the problem "reflexivity"; market moves affect external
reality.

Thus the currency crash sharply raises the risk that emerging market
nations could default. It inflicts losses on multinationals in the
emerging markets and makes planning for all multinationals virtually
impossible. So the crash is reflexive and causes more problems in the
real world.

But it is not wholly self-reinforcing. It has had reinforcement from
outside. This week brought news that the U.K. is in recession and that
China, the motor of the world's growth, is slowing down. Earnings figures
emerging from corporate U.S. suggest the recession is biting, but brokers'
forecasts have not caught up with reality, still projecting double-digit
percentage gains in profits for next year.

Can a carry trade truly form a "bubble"? The forex market is a set of
zero-sum games. When one currency moves against another, one side
benefits directly at the cost of another. An underlying store of wealth
cannot increase, as it can in stocks or commodities.

But in the past week, high-yielding currencies are behaving exactly like
an asset class in a bubble. Such sharp devaluations in the past were
because government attempts to peg prices broke down. There is no
precedent for currency moves on the scale of the past week's in a
free-floating environment.

Further, this sell-off was indiscriminate; every high-yielding currency
fell catastrophically.

Now we know the world is on a yen standard, history looks different. In
yen terms, the FTSE-100 is its lowest in 13 years, and the S&P 500 is at a
12-year low. The S&P is down 57 per cent from its peak, on the yen
standard. The FTSE is down by two-thirds.

Viewing the world in yen terms should have made obvious that equities were
in an unsustainable bubble. From a low in 1994, the S&P quadrupled in yen
terms before peaking. In the past three years, Brazil, the most popular
emerging market recently, gained 267 per cent and then lost every yen of
it.

With no precedents, it is hard to see where a general currency sell-off
could end. But forex is behaving like a crashing stock market, and stock
markets tend only to find a level once they have overshot and become too
cheap. For many in the emerging markets, that could be ruinous.