Monday, October 27, 2008

The Debts of the Lenders: The End of the Carry Trade Part 3

The near zero savings rates offered by Japanese banks forced many households to shift their money abroad in the search for higher yield over the past 15 or so years. They found the greatest yields in the form of emerging market equities and bonds. Lower - but more secure - returns could be found in Western European and American markets.

Unfortunately, the economic turmoil that started in the West is driving many Japanese to repatriate their funds. That's right - they are going through the same kind of fund redemption as the US. Ironically, their spending power is increasing as their equities markets tank - just like ours.

BUT, the story takes a darker turn. Unlike the US, Japan's fundamentals aren't as impaired. The Japanese do NOT have a network of 700 odd foreign military bases, massive foreign aid promises to other countries, and a sea of corrupt bankers to bail out (they already took care of most that back in the 90s).

Translation? Speculators - including US funds - are piling onto the Japanese yen. This possibly includes US pension funds which are MANDATED to seek safe harbor investments.

Finally, the Japanese are also in a demographic crunch - a substantial portion of their population are pensioners. Japan now is the USA 15 years in the future demographically; many seniors with declining birthrates. These seniors are going to have to start dipping into their retirement accounts more steadily.

Nothing goes up or down in a straight line. But the overall trend for the yen is up. And the trend for the Nikkei is down. The spillover effect on the US market is unmistakable - forced unwinding. In the long term, the more damaging effect is the aversion to US financials and most forms of structured finance.


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