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Minyan Mailbag: Rates and the Yen/Dollar Relationship


There is no way out of a credit crunch other than letting the market correct the imbalances...

Dear Mr Practical,

I remember a few years ago you stated that "the long dollar, long U.S. bond position that the Bank of Japan owns will begin to net lose if the dollar drops below 105 yen." Do you still feel that if 105 yen is breached, the BOJ would think twice about holding U.S. bonds or has that level changed in your view?

Thanks in advance for your comments. I know you are extremely busy of late.

Warm regards,
Minyan Dennis


All the imbalances I have been talking about, the huge trade deficits carried by the U.S. versus Asian economies and thus the huge consumer debt carried by Americans and financed by Asia, are beginning to cause huge pressures in the system. These pressures are leading the markets to correct these imbalances.

These corrective forces are re-pricing risk, pure and simple. Those exposed to risk, and those who own risky assets like stocks and real estate are seeing erosion in pricing as a natural consequence. They are screaming for help. Central banks should do nothing, absolutely nothing to interrupt this corrective process despite those cries.

It is the constant intervention by central banks and governments that have led to these cumulative imbalances in the first place. Every time the market has wanted to re-price risk, to curtail free credit, governments have stepped in and tried to lower government rates. This has worked in the past as markets erred on greed and sought to speculate with those lower rates. In other words, the market was cajoled into taking those lower rates.

Now the market has way too much debt. If the Fed lowers rates now in an attempt to ease the pain of the very rich who are suffering from lower multi-million dollar bonuses, I believe the market can no longer be cajoled into once again lowering credit spreads to stupid levels. Why?

Precisely because of the point you bring up. With Japan and the rest of Asia under pressure to raise rates, not lower them, if the Fed attempted to lower rates the dollar at this point would actually crash. Liquidity is going down rapidly because Asia is repatriating capital now. Asia already realizes that the U.S. is incapable of handling this problem. Investors there are taking back whatever savings they have been willing to "lend" to the U.S. The Fed lowering rates would only exacerbate that.

You can see that a stronger yen against the dollar (Japan repatriating capital) is causing U.S. stock prices to go down. If the yen broke 105 a year back Japan would begin to suffer major losses against its foreign currency reserves and the pain would increase for them. At some point even central banks must act sensible. But that 105 level is probably even higher now as this game has been played at higher and higher levels of dollar-yen. The pressures are greater now.

A Fed rate cut might embolden more speculation and pop stocks for a while. That is until the market realizes (perhaps immediately) that this is the same old "treating the drug addict with more drugs" prescription. I believe a Fed rate cut in the face of the rest of the world raising rates is almost an impossibility.

There is no way out of a credit crunch other than letting the market correct the imbalances I have spoken about. This is because a credit crunch is simply the market re-pricing risk. Somehow the bulls see this as temporary and that credit spreads will go back to stupid levels with a rate cut. They do not see that this is a permanent adjustment to risk and that the previous level was unrealistic.

-Mr. Practical
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