I recall back in the late 1990’s when we experienced a phenomenon called the “Asian Flu”. This was because the Russian Financial System collapsed and the ruble was devalued. This effect had ramifications not only on Russia but Asia and then the United States.
However it didn’t affect the US dramatically as the United States economy at that time was roaring and we weren’t really considered a “global economy” at that time. It affected stock prices but not dramatically; so companies that had an exposure to these markets saw their stock prices drop somewhat. The key word here is “somewhat” as they didn’t fall off a cliff.
Fast forward to today, now we’re in a global economy whereby one dropping domino affects another. Case-in-point, since the beginning of this year Japan announced that it would use government intervention to ensure that their currency, the Yen remains low. They wish to do this as if the Yen remains low it will make their products and services overseas cheaper in price. I’ve written about this in past articles (The USD Why is it so High?). This past week we’ve seen the ramifications of this as the Nikkei has dropped considerably in value. It seems that each and every day that exchange is dropping in value to the tune of triple digit territory.
The strategy employed by Japan is called “Abenomics” named after their new Prime Minister Abe. The Japanese appear to be adamant about keeping the value of the yen at an all-time low. This is consistent with their philosophy on business. When the Japanese first imported goods and services into the United States their philosophy was market share, market share, market share. In other words do anything you have to do to attract market share. If you have to sell your goods cheaper than anyone else, do so. At first we thought this was Japanese Junk. In fact we advertised it as such; making Japanese made products the equivalent of junk. We found out rather quickly that this wasn’t the case at all.
Given that the Japanese markets are going down in value, this has a ramification on Europe and additionally the United States. Europe which currently is wrestling with recession and high unemployment and the United States which hasn’t clue on where it stands economically is taking its cue from Asia. Seeing a major exchange like the Nikkei drop by triple digits day after day is not indicative of a positive effect on markets worldwide.
What do I think is happening? I think the Japanese completely underestimated the effect of the yen carry trade. What is the yen carry trade? This is the situation where an entity (bank, corporation, etc.) borrow money from the Japanese at a lower interest rate. They then invest in economies that are paying a higher rate of interest (Australia, New Zealand, etc.) with the difference being their profit. But what happens when Japan’s market drops dramatically and then sets off a worldwide downturn? Then the markets of those “invested” countries drop, set off a panic and everyone flee to a “safe haven”. That “safe haven” used to be Gold but now it appears to be Bonds. Bonds traditionally for the US markets were always considered an alternative to the stock market. So if the equity market wasn’t doing so well, sell your position and move to bonds. A true telltale sign will be if we start to see Gold increase in value. If that starts happening then we know the downturn is real…