Currency wars kick off as Japanese yen tumbles to 35-year low; Bank of Japan spends initial $59bn to defend it

We warned here in October that Asia’s currency crisis was starting to approach its endgame:

“Last week, the Japanese yen fell through the US$ : ¥150 level for the first time since 1990. It has now fallen by nearly 50% against the US$ in the past two years.

“The currency is behaving as if Japan were a 3rd world country. Yet it is actually the 3rd largest economy in the world. Clearly, something is wrong, very wrong.”

And now, as the above Bloomberg chart confirms, the endgame has begun.

THE HISTORY OF CURRENCY CRISES SUGGESTS THE BANK OF JAPAN WILL LOSE THE BATTLE

The issue is simply that Bank of Japan (BoJ) is now battling with the speculators, who expect the yen to fall much further.

The crisis has been building for years, as former US Treasury Secretary Larry Summers has warned:

“The utter failure of the Bank of Japan’s extensive efforts to raise inflation suggest that what was previously treated as axiomatic is in fact false: Central banks cannot always set inflation rates through monetary policy.”

Today, the BoJ faces a binary choice:

  • Its interest rates are well below world levels. And the history of currency crises suggests it either (a) needs to rapidly increase them to world levels or (b) risk seeing sustained pressure on the yen
  • Japan can’t really afford to increase rates as its debt is >250% of GDP. But the yen has already fallen to a 35-year low versus the US$ and has broken the key resistance level of US$1 : JPY 152.

Can the BoJ win the battle with the speculators? It seems unlikely. Every hedge fund in the world knows how the game is played.

If they have forgotten, they only have to look at the history of UK sterling crises. The recent short-lived disaster of the Truss premiership in 2022 is a handy reminder.

ALREADY, THE BoJ HAS BEEN FORCED TO STAGE 2 OF THE BATTLE

Essentially the pattern goes as follows:

  1. The currency goes down: the authorities try to talk it up and say how well the economy is doing
  2. The markets ignore them, so you sell dollars or euros and the currency rallies for a bit
  3. People do their sums, and decide you probably can’t afford to do much more of that
  4. So more selling takes place – and you can’t afford to intervene  again- so you raise interest rates
  5. That works for a bit, and then people realise the economy can’t stand too much of that
  6. So they sell the currency again and you raise rates to very high levels…and then the game ends

Every crisis has its own rhythm. But already it is clear that we are at Stage 2 as the second Bloomberg chart confirms.

The BoJ had to spend $59bn from its forex reserves to defend the yen last week. And even that vast sum only led to a 3.5% gain for the yen.

THE US WOULD LIKE A WEAKER DOLLAR, BUT RATE CUT HOPES HAVE FADED SINCE DECEMBER

Central banks usually try and support each other. And certainly the US Federal Reserve has been doing its best to talk the dollar down since December:

  • As the Aptus chart shows, it encouraged markets to believe there could be 6 rate cuts during 2024
  • But unfortunately, this meant consumers thought it was a good time to buy, with rates likely to fall
  • And so inflation has been rising in recent weeks – meaning there may not be any rate cuts this year

A MAJOR CURRENCY CRISIS IS NOW HIGHLY LIKELY

And so today, we have a potential currency crisis ahead. The yen is very weak versus the US$. And so are the other 3 major Asian currencies as the charts show:

  • China’s currency is very weak against the US$; the Indian rupee and Korean won are also very weak
  • Importantly, given China’s rivalry with Japan and its focus on exports, the yen is very weak versus China’s Renminbi
  • Unless the BoJ manages to support the yen, China will have to devalue, setting off a chain reaction

The risk is obvious.

These 4 countries are the 2nd, 4th, 5th and 14th largest economies in the world. They are all focused on export-led growth based on a weak currency.

Japan, China and S Korea have high levels of debt to GDP (China 295% of GDP; Japan 252%; S Korea household debt 101% of GDP).

They also have ageing and declining populations, so their debt probably cannot be repaid

India has a young and growing population, but is too poor (GDP/capita just $2731) to replace them.

THE USA IS UNLIKELY TO SIT BACK IN AN ELECTION YEAR

2024 is an election year in the USA. So the Administration cannot simply sit on its hands, and watch the dollar rise versus the main Asian economies. It will have to respond as US Secretary of State, Antony Blinken, warned last month in Beijing:

“China alone is producing more than 100% of global demand for these products (solar panels, Electric Vehicles, batteries), flooding markets, undermining competition, putting at risk livelihoods and businesses around the world.

Now, this is a movie that we’ve seen before, and we know how it ends – with American businesses shuttered and American jobs lost.  President Biden will not let this happen on his watch.  We’ll do what’s necessary to ensure that American workers can compete on a level playing field.”

This is the 3rd time we have forewarned of an approaching crisis. Both previous times, ahead of the Great Financial Crisis and the Covid pandemic, we were told we “didn’t know what we were talking about“. And nobody did anything to avoid the looming disaster.

Let’s hope its “3rd time lucky” and “this time is different“.