USD.JPY

Do We Really Want a Strong Dollar?

By John R. Taylor, Jr.

In a few hours, I will be participating in a debate on the dollar and how the country should manage it. The issue we will discuss is: America Doesn’t Need a Strong Dollar Policy. Fredric Mishkin, former FOMC member, and I will be arguing the affirmative, while Jim Grant and Steve Forbes will take the negative. Considering the histories of our opponents, I fear the topic of gold will be raised and you can be sure Rick Mishkin and I will do our best to argue the economy does not need to be bound in a rocrustean bed and that we humans, imperfect as we are, can do a better job than a metal extracted from the ground. We are hoping gold is only a side issue as it seems to us there is quite a bit of confusion and misinformation surrounding the management of the country’s dollar policy. A deeper understanding of the issues and the impact of the dollar on our everyday lives and how that should direct the appropriate policy stance of the US at any point in history would be informative in general and critical at this historical point. It is surprising there is so little discussion, so much so that the disagreements implied by the current political spectrum very seldom arise. Although this is a central issue for the global economy, the issue is buried so deep in our brains (most likely the reptilian part) as a ‘strong dollar’ surely adds to our national swagger. The Washington establishment seems to follow that policy, endlessly repeating the mantra that the US believes in a strong dollar policy. However, the decisions taken by the government officials directly involved often say something very different. We would argue that the Fed’s activities are among the primary reasons the dollar has been weak, and we think they are on the right track. Although we find the Fed’s stealth weak dollar policy at the moment just right, there are times that some other strategy would be more appropriate. Like any other policy tool, it has many possible settings. Currently, with low inflation, high unemployment, a negative trade balance and a net deficit in overseas assets, a strong dollar would be the wrong strategy. When Volcker and Reagan opted for a strong dollar in 1980 it was the right prescription for a US economy, which, at the time, had high inflation, no employment problems, a balanced trade account, and a strong overseas asset position. In 1953, Jan Tinbergen won the first Nobel Prize in Economics for his macro theory of controllability, in which the value of the currency was one of the four independent variables that controlled the course of the three dependent variables defining economic success: high employment, low inflation, and a good trade balance. We believe the Nobel judges were correct. Currency policy must be flexible. In the case of the dollar, which serves not only as a critical input to the US economy but also as the anchor of the entire global financial system, the correct policy is much mo re difficult to achieve. Tightening domestic credit and driving the dollar higher means the rest of the world suffers. As the dollar is the currency of most world trade and also the one that funds most capital investments,
its strength – implying tight liquidity – depresses global growth. A weak dollar means the cost of financing is low and the US banks are making money, but it might not be the right policy for the domestic economy. The complexity of the issues surrounding the value of the dollar demand freedom of action, rather than “crucifying mankind upon a cross of gold.”

Japanese Investors Start to React to the Weak Yen?

By Jonathan Clark

Japanese investors, both corporate and private, have a distrust of equities and have become used to very low yields on debt. This helps to explain why Japanese investors are believed to have largely missed the 44% rise in the Nikkei 225 and the 17% decline in the Japanese yen since Shinzō Abe began his campaign to become Prime Minister in the middle of November. The reason the yen movement is so significant to Japanese investors is that they constitute the currency gains they would have versus the dollar, and even more for some of the emerging currencies in addition to the underlying gains on these investments. There is a downside to yen weakness that comes in the form of higher prices for imports, the most significant of which is energy. Japanese utilities are looking to raise rates on their customers by 15-20% due to the added cost of imported oil needed to produce power now that the nuclear plants are closed. Japanese investors hold more of their assets in cash and near-cash than most countries. Rising inflation may finally force them to change their behavior, as negative interest rates force money into higher risk investments, both domestically and offshore. Japanese consumers have liquidated a net ¥3.6tn ($37.5 billion) of foreign securities during the past 1½ years and only recently has this trend started to reverse. Japanese funds are starting to increase the number of foreigni nvestment funds available to investors, which should cause money to flow out of Japan and this will further weaken the yen. The policies introduced or planned by the Abe government are improving consumer confidence which, in February, was the highest level since the middle of 2007. The Bank of Japan is virtually guaranteed to embark on an aggressive quantitative easing program. Haruhiko Kuroda will become new governor and this should force down interest rates and eventually increase inflation. The Japanese fiscal year finishes at the end of this month, and this has historically caused dollar/yen to rise due to the repatriation of foreign earnings and efforts to make balance sheets appear more attractive.

USD/JPY should pull back into early next week, but should avoid much weakness before the uptrend resumes. The support at 95.00 should contain any weakness and if seen, should be a good place to buy. It should then turn higher and rally into late next week. Following this peak, the dollar should pull back for a week before the uptrend resumes in the week of April 15 or the following week. Our target is the 98.25 area. This overall strength should last into the end of the year, and our longer-term objective is the 105.00 area.