I'm on the verge of giving up trying to follow the global financial meltdown. The numbers have stopped making any sense whatsoever. The latest problem is a surging Yen. The Japanese government will have to intervene or see its big exporters clobbered. See charts below for US$ vs. Yen and Euro:
WTF? I've already spewed plenty about how the US $ is too high, but what's with the Yen all of a sudden? The explanation offered in the business press is that the carry trade is unwinding. What this means is that for the last 10 years investors have been borrowing where interest rates are low (Japan and USA) and investing where rates are high (Russia, Brazil, etc.). Now these investors have to unwind the trades, selling assets in Brazil, etc. and buying Yen to pay back the loans. On the surface, this makes sense. But why? Why are they unwinding those loans? Interest rates are not rising in the US or Japan. Sure the assets they bought in Russia, Hungary and other places have lost a ton of value, but those are reasons to stand pat, not sell. More fundamentally, the carry trade should by definition be a transient opportunity. If anyone can get rich throwing Yen at Rubles, then everyone will. Eventually, the opportunity disappears as the traffic depresses the Yen and raises the Ruble. Eventually is a very short time in currency markets. Usually hours or days, not years.
The only way this all makes sense to me is if Russians were borrowing Yen to buy Ruble denominated assets. As long as oil prices go up, this is a winner because Russia sells oil and Japan buys it. The Japanese don't have to specifically buy Russian oil for the math to work. If the Japanese economy is slumping (low interest rates) and Russia is booming (a rising stock market), then its even better. But as soon as oil starts declining in Yen, you're fucked. You have to sell assets into a declining market to repay the loans. And you had better move fast because if you are slow the Yen will shoot through the roof and your pain will be multiplied. Its even worse if you have been financing long-term asset purchases with short-term debt. This is exactly what happened in Iceland. People financed their home and car loans in Euros, but get paid in Kroner. When the interest rate on Euros was 10% lower than on Kroner, it made sense. But taking the loans (selling Euros to buy Kroner) inflated the value of the Kroner. As soon as something went wrong, the Iclanders were collectively selling lots of Kroner to buy Euros and pay back the loans. The bottom fell out of the Kroner and Iceland has effectively run out of money that will be taken by anyone outside the country. This winter, they will be eating the fish they catch and the vegetables they grow, and little else. That's why the strategy of borrowing in foriegn currency to finance local investment is fundamentally stupid.
Iceland is making a humiliating trip to the IMF and Europe is holding its breath. All the Euros and British Pounds tied up in the Icelandic Banks and consumer loan market are potentially lost. The resulting panic is part of the reason the US$ has gone up so spectacularly. People are selling everything in a suspect currency for the safe haven of US Treasury Bills. The IMF has now lent money to Ukraine and Hungary. Pakistan and Belarus have lined up IMF meetings. Turkey is currently in denial, but will join the queue soon. Russia should be next for the high-jump, but even at $60 they are making money on oil exports so a Ruble crash looks unlikely. Most of the other old Communist East European and Central Asian states are all looking shaky. Poland particularly, but they will get some cushion from the EU.
At this point, the rising Yen will expose new fault lines in Southeast Asia. Big exporters with narrow asset bases and overseas financing like Vietnam will begin to feel the pain. Even the IMF doesn't have the money to save everyone. What will happen then? Nobody knows, but its not good. As usual, the developed world will probably do ok, especially if their economy is based on digging stuff up and selling it, like Canada. Those hurt the worst will be the poor and the exporters, especially developing exporters. If credit continues to be tight inside the industrial economies (and it remains tight), then the money available to exporters will dry up. Think of a factory owner in Indonesia making stuff under contract for Nike or Pentax. Where will they get the money to built the stuff when they don't get paid for months after delivery? US$ or Yen denominated debt has shot out of reach and nobody feels like taking a chance by lending in Rupiah. Even Nike and Pentax aren't in a position to lend. Nike is facing a nearly frozen credit market in the US and Pentax just got torpedoed by the rising Yen.