The Japanese Yen Trade Is Exporting Inflation to China

EconMatters's picture


By EconMatters

3-Month Depreciating Yen Trade

The 3 month Japanese Yen trade which every fund manager from San Diego to Hong Kong has taken part in will sure help Japanese exporters and help spur more economic activity in what has been a real laggard in both business competiveness, and the race to weaken their currency that has occurred during the last five years. 




However, there are very few free lunches in the world, and I imagine there will be some costs or unintended consequences of this newfound commitment towards a weaker Yen.

Almost every currency has appreciated against the Yen the past 3 months, and the original target was placed at 90 for the USD/JPY cross, now analysts are targeting 100 for the cross.


On October 1st the JPY/CNY cross was 0.0806 and today the currency cross is 0.0697 for a pretty significant move against a currency who doesn`t like to strengthen against anybody if they can help it.


China has made an art out of currency manipulation, and built an entire competitive advantage on having an undervalued currency.




Inflation is Back!

On Friday, China reported that inflation jumped to a six month high in December rising from 2% in November to 2.5% for consumer prices in December, the highest reading since June of 2012. The rise in consumer prices was attributed to the colder winter which reflected smaller crops and higher vegetable prices.


Well, a strengthening Yuan cannot be good for inflation as it just attracts more hot money into the country, and this sure cannot bode well for those hoping for additional stimulus measures coming out of China to spur economic growth in an economy that has struggled the past two years with higher inflation and lower trending growth.


There will be a lag before some of the effects of this substantial currency move by the Japanese Yen gets pushed through the Chinese economy and all of Asia for that matter, but it bears watching if the pattern of a depreciating Yen continues.


Short Euro & Buy Gold Trade

The last trade that was this popular was the “Short Euro Buy Gold in Euros Trade” that was popular for quite a spell in 2012.


This trade had a nice run, but really came apart towards the end of 2012, it was equally crowded with everyone from Hedge Funds to your local Greek cab driver, and if you polled most participants at the time, they all thought the end game for that trade was much higher in terms of Gold priced in Euros.


Well, the Euro strengthened considerably and Gold failed to take out previous resistance in terms of the Dollar, and the entire trade rolled over, forcing Gold to be sold into as the year ended with the entire trade falling apart rather aggressively.



The Rebirth of the Carry Trade

So the Japanese Yen has weakened to such a degree in so short of a time and has brought back many carry trades, which has helped fuel the rise in both equities and oil. 


However, things have been pretty smooth sailing with the end of year run-up, and money freely flowing into the New Year. Let`s see how that trade holds up with the first spike in volatility which is undoubtedly going to rear its ugly head sooner rather than later.


Let`s see how many traders run for the exits the first 4-day earning`s related selloff or Debt Ceiling Standoff that tests ratings agencies patience.


This is the true sign of whether the trend is more than a Hedge Fund fad, or has real legs that can be sustainable for two to three years, long enough to bring back one of the greatest of all carry trades in the history of modern day financial markets the Yen Carry Trade.


The Euro/Gold Trade turned out to be unsustainable, a mere fad in trader lexicon. It remains to be seen how sustainable the recent enthusiasm for the Weak Yen Trade is for the long term.


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One World Mafia's picture

It’s a fallacy that a rising currency will mean you can’t export bc two things happen when you have a strengthening currency that reduce your overall costs. #1 is your raw material costs. Your components that you import from around the world will become less expensive for you. Also your capital costs will be lower. When you have a strong currency businesses can borrow money at more favorable terms bc the lender knows they will be paid back in a currency that’s not losing its value. So historically if you have a strong currency you have a lower cost of capital and you have lower raw material costs that help you be competitive.

The only reason you are exporting is to import. You are exporting to finance your imports, and if you can export less to import more you are better off bc you don’t have to work as hard to consume the things that you need. The idea that I’m going to have to lay people off if i don’t debase my currency, that’s the same thing as cutting their wages. What you are saying is we have to find a way to lower wages other than a pay cut. Lets just fool them into accepting a lower pay w/o their knowledge bc we are debasing the value of the currency in which they are paid, and if you look historically, the US had a very strong currency when we had trade surpluses. We now have a weakening currency and we have trade deficits. The Japanese yen was much stronger during the 70s and 80s than it is now. It was rising sharply yet they had trade surpluses the whole time. Same thing with Germany. Germany still has a trade surplus, but Germany, when it still had the Deutsche Mark, the Deutsche Mark was strengthening thru 70s, 80, 90s against the dollar and its trade surpluses were growing. America with its weakening currency had growing trade deficits.

So it’s just not true that you can increase the real value of your exports by debasing your currency. You might be able to increase the nominal price that you receive for your exports, but that doesn’t mean anything if you can’t buy anything with that. What’s the value of Zimbabwe’s exports?

WhiteNight123129's picture

You are correct but in hte medium to the long run. In the short term strong currency hurts. The politicians always favor the expedient thing so they go for the short term small fix BUT long term trouble solution. So you can implement this strategy over the long run, in the short run you are getting hurt a lot.

That is the dilemma that Spain is facing, the austerity would work but the patient is so weak and their competitive gap is SO LARGE that you might kill it with the medicine. The best would be for people to keep pounding with Draghi making a threat to print but not printing that much in reality. If the EURO strengthen that is a problem. The strategy you describe works beautifully when applied early. What Germany is trying to impose is very risky for teh Greek and Spanish patients. It would be a miracle if the patient makes it through the treatment. The other solution is exit the euro and that is really really messy, historically that is the path of least resistance however.

When you are faced with external drain you tighten. That is what Nixon should have done, tighten and restore terms of trade. When you have an internal drain however, tightening is not what you should do. When you face both an internal and external drain at the same time like Spain and Greece well you are fucked. 


Popo's picture

This is partially true, but case specific. The analysis comes down to: What is the percentage of labor-value in the finished export product vs. other non-labor input costs?

For example, if a nation's export products are (e.g) petroleum by-products and distillates, and one is not an oil producer -- then your analysis is correct. A higher currency value reduces the primary underlying input cost (ie: oil, in this case).

But if a nation's export products are heavily labor intensive, with labor representing the primary input cost then a devalued currency becomes a greater relative factor in reducing the final price of the export product.

Also, the effect of relative currency values on raw material input-costs is mitigated in many cases with large sovereign currency swaps like those between China and Brazil. And mitigated by sovereign investment in offshore raw materials production (eg: China and just about everywhere in Africa).

One World Mafia's picture

"But if a nation's export products are heavily labor intensive, with labor representing the primary input cost then a devalued currency becomes a greater relative factor in reducing the final price of the export product."

Debasing the currency debases the real value of what the laborer receives so it's like giving a subsidy to the nation that receives the exports at the expense of the laborer, which is what has been going on with nations like China racing to debase their currency and prop up the US. That is how the US has exported its inflation to China.

WhiteNight123129's picture

Whoever was long Gold in Euro had the trade upside down, now we only starting to see an opportunity for tha trade, wait for everyone to give up on Gold in euro to put it in, the more people bash Gold in euros, the stronger the euro, the tighter the periphery sovereig spreads, the more it is out of balance with an asphyxiated Spain, then you put the trade on, cover a bit of Treasuries short and shortconsumer discretionary in the US.

Dewey Cheatum Howe's picture

Unless I am missing anything any inflation relative to their goods shouldn't be due to the YEN since the Chinese are flat out boycotting all Japanese imports right now due to their lovers spat?

BlueCheeseBandit's picture

Short EUR and long gold a fad, eh?

Let's see how that works out.

Just because too many people follow others into a room, not knowing why they're there, and then want out doesn't mean being in that room is a bad idea.

joego1's picture

I feel secure knowing that when the great electronic money machine goes blink for the last time that I will be happy in my barb wire fenced bomb shelter eating 2 year old MRE,s and counting junk silver piles over one over again. The good life!

oak's picture

could this weak yen policy fuel infation everywhere but japan?

BlueCheeseBandit's picture

Man I love you Chartists. Just took a look at your euro slides. Remember that time EURUSD hit 1.70 in 2011? Me neither, but that's what your models said.

I'll invest my own way, thanks: Throwing bone dice on a pentagram of virgin's blood.

I outperform most hedge funds.

jldpc's picture

clue us in; where did you get the virgin's blood?