By Mike Dolan
LONDON, April 19 While many investors have greeted the prospect of new Japanese money flooding world markets as a windfall, some strategists warn a sliding yen could yet shock Asia and developing countries.
The Bank of Japan's aggressive reinforcement of quantitative easing and its pledge to end domestic deflation have been widely predicted to push some Japanese investors overseas in search of better yields.
Many high-yield emerging bond markets, such as South Africa, Turkey, Brazil and Mexico, have in the past been favoured by Japanese retail investors in particular and have again been touted as possible beneficiaries from the BOJ push.
Although the weekly fund flow data still shows net investor inflows to Japan since the April 4 BOJ announcement, Japanese investors such as the country's giant insurers have indicated they will be upping foreign bond holdings in the months ahead.
However, Japan's yen has already plummeted more than 20 percent in anticipation of this month's action - and some analysts draw uncomfortable comparisons with the triggers for the Asian and global emerging market crises that began in 1997 and set off serial currency collapses worldwide.
Famously bearish Societe Generale strategist Albert Edwards, renowned for his forecasts in recent years of a global economic "Ice Age", told clients this week that the yen slide could well be a "1997 redux".
"It seems investors may have forgotten that yen weakness was one of the immediate causes of the 1997 Asian currency crisis and Asia's subsequent economic collapse," Edwards said.
As the dollar/yen exchange rate sank below 80 in 1995, due partly to U.S./Japan trade tensions, a U.S. Treasury market selloff and the effects of Mexico's "Tequila" debt crisis, the G7 central banks decided to intervene to halt the steep slide.
But over the following two years, the dollar surged more than 50 percent against the yen and put enormous competitive pressures on dollar-targetting currencies across Asia from Thailand to South Korea and Indonesia.
A series of devaluations and steep currency depreciations ensued, stressing local banks and businesses with heavy borrowings in dollars and hard currencies and sending import prices soaring. The contagion swept the region and emerging markets from Russia to Brazil for the next three years.
Of course an awful lot has changed since the late 1990s. China has overtaken Japan as the world's second-largest economy and regional economic lynchpin and there's been a dispersion of manufacturing supply chains across different countries in Asia that complicates the issue of relative currency competitiveness.
What's more, the export-focussed growth strategies adopted by China and other Asia economies since the crisis have sucked in foreign exchange reserves that will protect them against regional or global crisis.
But Edwards reckons the echoes of 1997 are still strong. Back then, many Asian currencies stayed pegged to a rising dollar even as their national balance of payments deteriorated and they quickly became overvalued, unnerving foreign investors.
Devaluations were eventually forced in Thailand and elsewhere and they set off a chain reaction.
China may be the new centre of gravity, but its broad yuan exchange rate - due in large part to an effective peg to the dollar - has been pushed 10 percent higher in real terms over the past two years even as the country's balance of payments position has weakened.
And "China is not the most vulnerable of the EM currencies to a weak yen, but this conjunction could easily trigger a currency crisis as growth is crushed," Edwards said, adding that heavy selling of Asian central bank reserves to stabilise the situation would merely hit growth by draining liquidity from their economies.
NEXT YEN MOVE KEY
Even investors more positive about the global economy and emerging markets acknowledge the competitive hit that the yen's fall will have on exporters from South Korea to China and around Asia - and also on big western exporting nations like Germany.
But, as JPMorgan Asset Management strategist Dan Morris points out, the yen retreat so far is at least partly a reversal of its crisis-driven 'safe haven' role. He reckons it can likely be absorbed without too much disruption for now and it's not at all clear there is much more weakness to come.
"A 25 percent yen move is clearly not trivial in terms of exporting discounts, but we have seen these sorts of moves elsewhere, even in the UK," said Morris. "The question you have to ask yourself in terms of the longer-term implications is what's going to happen the yen from now on."
Edwards' gloomier view, for the record, is that the yen will weaken much further because the Bank of Japan could lose control of the printing presses.
He reckons success in generating inflation would put unsustainable upward pressure on Japanese government bond yields, given the scale of Japan's debts, and force ever more BOJ bond buying to rein in its borrowing costs.
BACK TO '90S?
For investors looking at yet another year of emerging equity underperformance - due variously to slow demand growth in the West and falling return on equity or profitability at many emerging companies - the bearish view is hard to ignore.
Although many point out that broad emerging index losses mask a big dispersal of returns and markets such as Indonesia and Thailand have done well this year, benchmark bourses in China, South Korea, India, Russia, South Africa and Brazil are all in the red for 2013.
And even if you think the yen move is not as significant on its own, other strategists have warned this year about the impact of a broader-based, multi-year U.S. dollar revival driven by shifting U.S. economic dynamics.
Morgan Stanley economist Manoj Pradhan has said this year that a re-industrialisation of the United States inspired by cheaper domestic energy and more competitive long-term exchange rates and wages could help U.S. firms move back down the value chain and start competing with emerging counterparts head-on.
Not only could that change the competitive landscape for emerging market companies but it also builds a case for a steady dollar appreciation as U.S. trade deficits fall and Federal Reserve monetary stimulus tapers off.
And just like the last prolonged period of global dollar strength in the late 1990s, the attraction of foreign currency investing for U.S. investors could be dulled significantly.