The Strengthening Yen Is Signaling An Ominous Truth For Europe

Includes: FXE, FXI
by: Global Opportunities Analyst


Recent rise in the yen is a clear sign that QE has failed in devaluation.

Investors have for long been focused on China ignoring the real threat posed by another euro crisis.

Yen's rise is the loudest warning signal that Europe's QE will fail.

I wrote an article a while ago arguing that the Japanese yen was the best bet, when the yen was around 116-117. The argument is too long to repeat here. The yen has since strengthened markedly, being 108 to the dollar now. This reality, on its own, may not seem remarkable as, after-all, Japan is not really one of the world's most important economies (at least from a growth perspective). The world has got used to a weak Japanese economy for decades and a continuation of Japanese weakness is unlikely to affect investor sentiment in America and other Developed economies.

But what is important about the rise in the Japanese yen is not the currency in question. It is the real and very strong signal it is sending about the euro! And I haven't yet heard anybody open this subject. Japan's huge QE has obviously failed to devalue the yen, which was the real desire of the Bank of Japan, and the Japanese government. I had, in my article, made arguments about why this would happen.

The euro is the developed world's most undervalued currency according to current account balances (chart below) which is what, in reality, determines the value of any currency compared to other currencies.

The market is still very apprehensive about the euro, not necessarily because of another, potentially much larger (and probably final), euro crisis, but because of what the ECB (Europen Central Bank)might do next to suppress the euro. The other issue is that Europe is much newer (than Japan) to this devaluation game using QE (Quantitative Easing). Thus markets might still be digesting what may come next.

My apprehension about the euro is not because of what the ECB might do next against euro's strength - as I believe (and I had also written about this in the same article) QE will prove inefficient in devaluation. My apprehension is about the catastrophic consequences that the next euro crisis might bring. And this is why I am not personally betting for euro strengthening.

If the yen has risen so much already, despite BOJ's attempts to the opposite, there is no reason the euro cannot rise a lot as well, easily above 1.20 to the US dollar. However, the problem with the euro is that one cannot know what will cause the next euro crisis. A strengthened euro can cause the next euro crisis, but there is also the possibility that something else (Brexit?!) causes it.

I am still short the Nasdaq 100, and I have seen that the market has gone against me. But I am still patient, though one side of the game is to be able to take your losses if need be. As the great economist and speculator, John Maynard Keynes, said "markets can remain irrational longer than you can remain solvent" - so the best way to approach the market is to be mindful of this reality and take your losses in case it becomes unavoidable.

Many people have for too long been focused on China, ignoring the fact that China's leaders are, unlike those of democratic countries, far more capable in controlling short term market gyrations. However today's indebted world is nothing short of trouble. Europe is no less of a threat to the world economy than China, and there is no strongman (like Mr Xi) in Europe to keep the lid on. Europe's fragmented political system is the best recipe for disaster when it comes to urgent cohesive economic actions. Japan can, eventually, devalue its currency using fiscal measures, though risking enraging its trade partners. Europe can do no such thing. It is simply impossible. I have also addressed this in another article before. Europe cannot handle a strengthening currency no matter what, because Europe does not have a central government to launch any kind of central fiscal stimulus. It remains to be seen, but what the yen is signaling is not important for Japan, but rather the loudest warning sign in the world for Europe. Europe needs to be alarmed!

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.