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
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
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.