Korea Economic Slice: The Fiat System, Asian Money Today and Tomorrow - September 2, 2010

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Permalink Reply by Tyler Joyner on September 1, 2010 at 10:05pm

Nice article, one of the best weekly Slice's so far in my opinion. I especially like the point you made about how currencies that are pegged to the dollar will devalue right along with it, in the likely event that the USD becomes devalued in the future. It seems obvious in retrospect, but I hadn't quite thought of it that way before.

I'm not quite sure we should be so quick to abandon predictions that the RMB will appreciate, though. China's "slowdown" is in large part due to the government actively slowing down the real estate market, among others, probably in order to avoid the kind of bubble and bust that is becoming almost endemic in the American economy. They're still clocking in at a gargantuan 10.5% estimated GDP growth this year, according to the IMF.

In my opinion the failure of the Renminbi to appreciate against the dollar is a short term event based on fear (which was pointed out in the article), and if the Chinese government continues to allow the RMB to free float, we'll see it go at least as high as 5 to the dollar within a couple years.

As for Yen becoming a safe haven currency, I'd definitely be interested to hear more about the reasoning for that prediction. The US was the go-to currency based on the idea that we would always make good on our debt without devaluing the dollar. Just because the Yen is increasing in value against the dollar doesn't make it a safe haven. To be a safe-haven, investors would have to believe that the Japanese government won't ever devalue the currency to pay off their debts.

Although I think that the Korean Won and the Renminbi are distinctly more safe than many other currencies at the moment (and would be a great investment), in terms of a safe haven I think we'll see a move to commodities, especially precious metals.

The biggest question in my mind is what moves China and Korea will take to keep the value of their currencies low enough to retain their export advantages, and how effective those moves will be.

Great article Robert, and I look forward to the next one!

-Tyler

Permalink Reply by Steven S. Bammel on September 2, 2010 at 4:13am

Tyler: Indeed!

And to think... Robert wrote this week's Slice during a typhoon at a PC room out in the Korean boondocks with a trial version of MS Word...

Way to go, Robert!... :-)

Permalink Reply by Robert Eberenz on September 2, 2010 at 8:48pm

Many thanks Steven,

I hope that readers enjoyed the piece... If you liked the piece and have any comment, please get in on the dicussion!

Thank you to all of our readers!

Permalink Reply by Robert Eberenz on September 2, 2010 at 8:41pm

Thanks Tyler, the positive feedback is much appreciated!

I think we're on the same page when it comes to expectations for the USD. The USD cannot remain THE standard among international currencies, and I completely adhere to your view on commodities (specifically precious metals) becoming the new standard for currency valuations.

When it comes to the RMB, government policy is going to play a large role. Inside analysts with connections to the leadership in China have explained that the RMB will be allowed to appreciate but very slowly. The consensus among western analysts is for a 3-5% appreciation over the next year. A jump from the current 6.8 USD / RMB to 5 would constitute a 36% increase in the RMB... I would agree that this valuation may make since in an unregulated free market system over the next few years, but that the Chinese government will protect their competitiveness by actively managing the float of their currency. There is however an off chance that the Chinese currency could devalue in the short term (i.e. 1-2 years), which would correspond to a bust in the real estate market and the ensuing decline in their rate of growth. There is no doubt in my mind that the China economy will be the major driver of growth into the next decade, but the immediate risks seem greater than the potential for growth when global consumers are emerging from recession in anemic fashion. Also a key point which is rarely noted by mainstream media, is that the Chinese stimulus plan injected the equivalent of 13% x 2008 GDP into their economy, yet expanded by roughly 11% in 2009. The math tells me that the economy could have technically contracted during that period if all funds were disbursed. Spreading the stimulus over a few years due to the scale of some of the infrastructure projects the stimulus would account for only 1/2 or 1/3 of growth, but the presence of these government funds in the economy are worth pointing out. There's no doubt that the GDP growth this year is impressive in China, but the purchasing managers survey is now showing growth barely above the break even 50 point. The next couple months will give a clearer picture moving forward and I maintain my position that the RMB will move parallel to the Chinese economy and semtiment surrounding its potential growth.

The JPY is a very interesting but very difficult safe to crack. There are so many factors at play with this currency that it is nearly impossible to explain. Historically, the JPY has been a major target of "carry traders", who were traditionally foreign investors that borrowed Yen at low Japanese interest rates and then used the loaned currency as a means to finance investments. The carry trade actually served Japan well, because the decreasing JPY as a result of carry trades helped Japan combat the low wage growth and price stagnation that had presented risks of deflation since the debacle in 1997. A lot of the JPY/USD appreciation over the past year has been the result of many carry traders shifting from JPY to USD. Since the U.S. Fed has reaffirmed its Quantitative easing policy, more money is continually being borrowed in USD and that has allowed the JPY to appreicate more.

However, the point of this week's slice was not to identify carry trades, it was to look at the risks of holding certain currencies due to economic shifts. While it may seem counterintuitive, the relative strength of the JPY is due to the "boringness" of it's economy. Since June of 2010, the JPY has picked up steam relative to the KRW and RMB, which I am attributing to a risk of recession that has begun to be priced into economies throughout Asia. Since Japan has yet to have a recovery and is one of the least exciting places for investments now, the currency has not spiked because of future growth expectations and the mature nature of the economy itself would allow the currency to be less volatile. My argument about Japan as a new "safe haven" should come with a footnote however... "This will be a short term (i.e. 6-12 months) phenomenon"... because the JPY is acting almost as a temporary holding zone for moneys that have appreciated in other Asian investments and are now being taken off the table as profits and put somewhere that is not expected to appreciate or depreciate by any extreme magnitude.

If you want my opinion, I'd say the JPY is ripe for shorting. Not in USD of course, b/c if the USD and JPY depreciate together you'll end up with no net profits. However, there are some interesting plays that go back to your suggestion of holding precious metals. I would suggest staying clear of copper because of the industrial factors that influence its price, but Gold has much more potential to move higher. By shorting the JPY (borrowing JPY) and buying January 2011 Gold Futures Calls (1250-1300 strikes), one could take advantage of the potential of JPY to normalize and the potential of Gold to rise relative to both USD and JPY. This would be a very leveraged play and should obviously represent a small fraction of anyone's portfolio, but it's a play I've been waiting on for a while that might be ripe for the picking!

When it comes to Korea and the KRW, it's a really tough call. The KRW is just so volatile. The economy is still labeled "developing" on most trading desks, and the sentiment of the international community simply hasn't matured as quickly as the Korean economy itself has. That said, Korea is a force to be reconned with and should not be dismissed. The KRW has potential to outpace its Hong Kong, Singapore, Taiwan rivals over the next year or so, as long as growth stays positive in the Asian region as a whole. If the "double dip" recession starts looking possible and investors begin preparing to weather it, the KRW will not be a hospitable place.

Long story short (and like you said), buy gold!

Permalink Reply by Robert Eberenz on September 3, 2010 at 8:09pm

Another interesting caveat to Japan and the JPY is the political unrest there at the moment. Mr. Naoto Kan, who had recently rose to power as Prime Minister, is being threatened by calls for ousting from Ichiro Ozawa. Ozawa's platform includes calls to borrow and spend, while the Kan plan was aimed at restructuring finances in Japan. Also, investors are shifting from bonds to higher yielding investments, as the past week's U.S. econ news gave life to risky bets. Finally, Japan's Pension Fund announced plans to sell assets this year, including Japanese bonds.

All above factors have led the 10 yr treasury note in Japan to fall by the most since May 2008. These rising yields on debts and increased uncertainty will certainly have an effect on the JPY. It's safe to say that the risk of insolvent spending practices will take precedent over any positive expectations of stimulus effects under a new regime run by Ozawa. Mostly, the volatility of leadership changes in Japan over the past year are enough to spook institutions from parking cash in JPY and makes now a very attractive time to get out of Yen, or even short it.

Permalink Reply by Steven S. Bammel on September 12, 2010 at 3:11am

I read something this week that the Japanese are upset about large Yen purchases by the Chinese and have demanded an explanation from the Chinese.

Robert: Do you know anything about this? Is that demonstrating the yen as a "safe haven" currency and if so, how in the world could the Japanese yen be a safe haven currency with its 20-year economic stagnation, incredibly high government debt and shrinking population?