It’s been said that in M. Taggart Murphy’s book, The Weight of the Yen, he forecasts a time when the JPY gets so strong on the back of deflation and the end of the carry trade that it completely levels the Japanese economy, and forces a long overdue restructuring. I’ve recently been chatting with others about such an outcome, and how it could progress to an extreme. We’ve come up with a thought experiment.
Imagine a no-growth world where the unwinding of the Yen carry trade is a chronic condition. As the Nikkei and the global economy melts, the JPY strengthens to 75. At this point, both the G7 and Japan have lost any ability to stop the Yen’s rise. Other high yielding currencies continue to weaken, and low-yielders strengthen. The Swiss Franc for example. And then, as the unwind of the JPY carry trade comes to an end, a new source of Yen strength is found, as the unwind of Japan’s broader position as an international creditor begins. Again, the premise here is that no one is long the Yen.
The Yen then goes to the unthinkable level of 25, against both the USD and EUR. Against commodity currencies like the AUD and CAD, it goes to 15. And against many emerging market currencies, it goes to 5. But here is where things get interesting, as the boundaries or limitations of this phenomenon are approached. At these levels, while the Japanese economy has been destroyed, Japan’s purchasing power has skyrocketed. It’s ability to purchase food, oil, and goods ascends to previously unheard of levels.
At this point, Japan has become a kind of dead star. It’s industrial economy has collapsed. Virtually no one is employed. The country continues to take in goods, but, produces nothing. The JPY is the strongest currency in the world. It’s become a kind of uber-claim on world goods and services. However, it’s also a claim on the dead star of Japan. Which is to say it’s a claim that no one really wants, or can use. It’s likely that during this period, most of the world has panicked into the Yen, thus reversing the multi-decade short position. Up to this point that trade has been the best trade in the world. And then, it reverses.
What I like about this thought experiment is that it may contain part of the road-map that’s coming for the USDollar. The structural position of the USD does not approach that of the Yen. The current global unwind into the USD has the prospect of a much shorter life-span. The reason for this is that while many leveraged players and investors in the States are invested abroad, the world remains structurally long the USD by a very wide margin.
The prospect for the USD from this point forward is risky. Very risky. Every week that it strengthens, it undermines any fundamental reason to own it, as USD strength since July has seriously damaged US exports. Unlike the Yen, the USD does not have the multi-decade short position to support it. And then of course, there is the looming supply of US Treasuries set to trigger further over the next two years.
The JPY and the USD are therefore not investments but trades, and cynical trades at that. And, that’s OK. But you’ll need to battle the world’s central banks if you intend to ride the Yen Dead Star to its ultimate conclusion.
-Gregor
