Euro And Yen: Opposite Economic Goals

by: Carlos X. Alexandre

Bloomberg reported on Tuesday that “Yen Erases Gain as Nikkei Says Japan to ‘Form Team’ on Currency Strength.”

The yen erased its gain versus the dollar after the Nikkei newspaper reported that the government and central bank will form a team of senior officials to oversee steps designed to address the currency’s strength.

This comes as no surprise, because this is a very old game played by the Bank of Japan, and understandably a high yen affects the country's exports. And on Wednesday evening we learned that Japan’s is getting creative, as reported by Reuters, although the yen was virtually unchanged overnight.

The Japan government decided to expand a lending program that will use government-held dollars to increase foreign acquisitions and investments in natural resources to about 10 trillion yen (about $130 billion), aiming to rein in the Japanese currency, the Nikkei business daily reported.

But the unusual excerpt pertained to Europe.

The euro erased its drop as Germany’s Chancellor Angela Merkel said the Oct. 23 summit of European leaders will send a signal to defend the currency.

Europe does not depend on exports as much as Japan, but a lower currency would go a long way toward helping the union solve its economic issues. But the fight is not the same, and, as I have indicated before, capital flight is the hidden risk that nobody talks about.

Angela Merkel’s determination to “defend the currency” only states that a devaluation is not welcome – and we’re back to capital flight risk. Investor sentiment is souring quickly and exponentially, especially because there is no credible good faith solution, and as time elapses the conditions will get worse, although there’s no shortage of creativity.

BNP Paribas (OTCQX:BNPQY), a French bank, offered the idea that credit default swaps should be issued to investors that buy new Italian and Spanish bonds, according to the Financial Times. That’s similar to receiving a free home warranty when buying a new house just in case something breaks down. Allianz (OTCQX:ALIZF) and Deutsche Bank (NYSE:DB) already had their own plan.

BNP executives acknowledge it is a tough sell but believe there are substantial difficulties with the Allianz plan. The latter would see the EFSF offer guarantees to cover the first 20%-25% in losses for the likes of Spain and Italy and potentially as much as 40% for Greece, Ireland and Portugal.

Thus, the conversation continues, and I submit that although one may correctly think that officials should meet behind close doors, hide their differences, and emerge with one solution and one voice, the ongoing rainbow of mixed messages is not only politically necessary, but also buys time and keeps investors off balance – or so they think.

But in a separate Bloomberg report, Ms. Merkel acknowledged yet another long standing truth, which may fly under the political radar, and shouldn't.

“These sovereign debts have built up over decades, so they won’t be ended with one summit,” Merkel told reporters in Berlin late today. While European officials recognize their responsibility to stop the crisis, “this will require tough, long-term work.”

Now the only missing statement is an explanation and admission as to why and how the debt was “built up over decades,” and how do they fix the system going forward. I have written about the answer, but many still and will not like the sound of it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.