Japanese Yen: The canary in the gold mine

The global monetary system is a big blobby glob of sticky goo that somehow keeps on slugging along through endless waste and war. But stop what you’re doing and listen. Chirp, chirp, chirp…peep, peep, peep…chitter, chitter, twitter, twitter, TWEET! On April 30, Fortune published an article: Why Japan’s currency is cratering right now, even though its stock market is red hot. High U.S. interest rates, it says. But who cares? What does it matter when we can get our sushi and wagyu from Whole Foods? By the way, I had some really good Japanese wagyu at Isetan in Kuala Lumpur, while jamming to the Don Don Donki song replaying in my head.

Fact is, the Japanese yen is the “canary in the gold mine” for what’s coming to the United States and the rest of the world. As of January 2024, foreign countries held a total of $8 trillion in U.S. treasuries, and Japan holds about fifteen percent, more than any other country: Japan ($1.15 trillion), China ($797 billion), the United Kingdom ($753 billion), Luxembourg ($376 billion), and Canada ($339 billion). Our national debt is now $34.7 trillion, but who will continue to buy and hold it is an important question to ask. Debt held by the public has increased by 118% since 2014. U.S. government holdings increased by 42 percent.

In February of this year, Reuters published Foreign holdings of US Treasuries surge to all-time high in December. However, this headline is somewhat misleading. Japan did boost their holdings from $1 to $1.1 trillion since 2019, but China’s holdings have dropped considerably from $1.1 trillion to $763.5 billion, the lowest since March 2009. While it looks like the UK has picked up China’s slack, for now, it’s interesting to think about this multiplying blobby glob of sticky goo, which has gone from 22 to almost 35 trillion over the last 4-5 years, only getting blobbier and stickier.

Jonas Goltermann, deputy chief market economist at Capital Economics, said “The key lesson from Japan’s travails with the yen over the past couple years is that what matters most to the currency’s fortunes is expected interest rate differentials” (from the Fortune article that I mentioned above). This is true because of what happened in 1971. The financial system, as agreed up by 44 country delegates at Bretton Woods, was abruptly broken. Before, foreign currencies were pegged to the U.S. dollar, which was pegged to gold. But in 1971, the dollar was detached from gold. For your reference, physical gold is the only sovereign asset held by the nations with no counterparty risk.

The chart below (from a previous post: This Means War, Part II) illustrates the financial system that was established in Bretton Woods. If you can your imagination for a moment, you might see a solar system in orbit with a green sun and pink planets. In 1971, the financial system’s star foundation, its sun, was removed and replaced with something that resembled a star but was not. If I were to translate it into a novel, or screenplay, some cabal stole the sun and replaced it with a battery-powered bulb that looked and acted like the sun but clearly wasn’t nourishing to life on Earth. In the same way, gold was replaced by credit, and currencies became dysfunctional.

Our solar system is the collection of eight planets and their moons in orbit around the sun, together with asteroids, meteoroids, and comets. This system only works with the sun. Without the sun, the orbiting planets disappear in a straight line off into space—and there is no more system. And if there is no more system, there is nothing to support life that depends on that system. As the planets are to the sun, currencies are to gold. Like planets with no sun, currencies with no hard backing have changed course from a semi-circular orbit to a linear path heading straight for a black hole. The only way to change this trajectory from linear to circular again would be to bring back the sun, and recreate the orbit.

In the natural world, think about what would realistically happen to us if our sun were replaced by a giant manmade bulb that depended on a limited supply of energy extracted from Earth, which depended on an ever-growing supply of technology and debt. We would probably become malnourished and sick, without knowing why. Then, in our will to survive, we would look for and invent strange ways to replace what we were missing from the solar-system dysfunction. A circular process is natural, cyclical, regenerative, and therefore sustains life. A linear process is degenerative, and eventually ends in collapse and ruin. The once orbiting currencies are now disappearing into the outer space of the world.

Currencies appear to have value in relationship to each other, but they really only have value in relationship to gold. Losing value against gold is called inflation in financial speak. In September 2022, the Bank of Japan intervened in the currency markets for the first time since 1998 to strengthen the yen. Last week, they intervened again by spending $40 billion to buy the plummeting yen, in an attempt to save it, and the very next day it started plummeting again! As Dr. Ingo Sauer, a German economist, explained in a recent interview, inflation is triggered by declining value of fiat. Inflation is fiat’s sickness and eventual death.

After World War II, Japan went from being a collapsed nation to the world’s second largest economy after the United States. This is otherwise known as the “Japanese economic miracle.” First, Japan gave up its expensive military and relied on the U.S. for protection. This helped them redirect their resources in a regenerative way. Second, Japan became a primary producer of equipment and supplies for the United States during The Korean War (1950-53). And in 1955, Japan became a member of the General Agreement on Trade and Tariffs (GATT). Then, in the late 1950s, it started cutting taxes, and equalizing incomes to boost production even more.

Japan adapted a centralized economic system to encourage the production of consumer goods. The Bank of Japan gave quotas to Japanese banks, limiting loans. This kept them in control of the types of projects that were funded in their society. Anti-monopoly efforts also motivated internal competition between companies, which made them better international competitors. By discouraging imports and promoting exports through tariffs, large corporations were able to grow rapidly, while the Japanese people made due with low living standards.

This centralized approach grew the Japanese economy hugely in a relatively short period of time. It was focused on competition over profitability. In fact, there was so much competition between Japanese businesses that market share became much more important than profits, and companies fought for it until bankruptcy. By 1968, Japan had become the 2nd largest economy in the world, after the U.S. At this point, Japanese corporations dominated markets. The world took notice and started shifting away from the U.S. dollar to consider the Japanese yen as the next world reserve currency.

In 1981, there was a congressional hearing: Japanese productivity lessons for America. A plethora of newspaper headlines on the Japanese miracle economy compelled businessmen to take lessons. While the narrative was that good education and innovative management were the key ingredients that drove Japanese productivity and huge economic growth, it was really Japan’s sharply undervalued currency and low interest rates that did the trick. Their weak currency made exports more competitive in global markets but made imports very expensive. High export volume translated into economic growth, similar to what the U.S. experienced by supplying the first and second world wars.

I see all this as the “gaming” of currencies, which are traveling on a linear trajectory to zero. It works for a while, but in order for a government to keep its currency weak, it must suppress consumption of its people while using accumulated savings to buy up the world reserve currency. This is why Japan is the largest foreign holder of U.S. debt. It is their piggy bank, their savings. While the Japanese were trapped in a low standard of living for a very long time, Americans were able to enjoy a high standard of living as the U.S. absorbed Japan’s excess savings by issuing more bonds and financing excess consumption in through cheap imported goods.

With Japan being extremely reliant on exports to generate growth, the U.S. started limiting imports of Japanese goods through tariffs. From 1980 to 1985, the dollar appreciated about 50% against the Japanese yen and other major European currencies. It caused problems for American industry and its exports, pricing the United States out of international trade. This led to the Plaza Accord, which was instituted in an attempt to rebalance the dollar in global trade. Consequently, the Bank of Japan allowed the yen to soar in value against the US dollar, and this made the Japanese people rich.

To prevent Japan’s trade surplus and massive growth from falling sharply, the Bank of Japan cut interest rates and began to significantly increase lending. It pushed banks to lend so much that the only way they could fulfill their quotas were to make non-productive loans to whomever they could. Banks went from carefully choosing and limiting borrowers to selling loans aggressively like snake-oil salesmen. Foreign goods were suddenly cheap to the Japanese, and with their incomes no longer suppressed, and cheap money readily available, the Japanese people flipped from being low-volume consumers to high-volume.

This now loose monetary policy did to Japan what just happened in the U.S. recently; it caused a massive bubble economy to emerge. Between 1985 and 1989, Japanese land prices rose 245% and its stocks rose 240 percent. The speculative frenzy became so great that Japanese businesses started investing in stocks and real estate, until nearly half of the profits from large corporations were from stock market investments. Asset and stock market prices skyrocketed, and some companies started making more money speculating in investments than manufacturing products. This is financialization, in process, to zero. This is the planets and currencies jetting out into space, but it doesn’t look and feel that way.

Wealthy Japanese people started buying up precious art all over the world. Sony Corporation bought Columbia Pictures. Mitsubishi bought Rockefeller Centre. A Japanese billionaire bought the Empire State Building as a gift for his daughter. While it seemed like a miracle at the time, the Japanese bubble of the 1980s was merely a hack. It subtracted more growth from the future than it generated in the present. And when the value of central Tokyo’s Imperial Palace was worth more than the entire state of California, the bubble finally popped.

After the bubble burst, Japan went back to deflation again. In a deflationary period, people expect prices to fall and therefore defer spending. This further harms economic growth. Incomes fall while the value of their debt stays the same, making it harder for people to pay off their loans. The bank of Japan tried to stimulate the economy by taking interest rates down to zero and then negative, but it didn’t really work. The government started quantitative easing, buying back its own bonds while spending excessively on public works projects like roads and bridges.

In a credit-driven economy, malinvestment fueled by cheap credit masquerades as growth. While an economy can appear to grow during a credit bubble, it must eventually pay the bill with real productivity that generates real money. Japan rebalanced in the only way it could, with a sharp contraction. This is what caused the lost decades that followed. In 1989, 32 of the world’s top 50 companies were Japanese, and now it’s only Toyota. In 1997-98, Japan’s banking crisis started, and seven major financial institutions failed. The 2008 credit crunch and the 2020 coronavirus pandemic caused even more hurt.

From the Yahoo Finance App

Just recently, the Japanese stock market has surpassed its high from 1989, but what’s happening to the yen? What’s the problem? Why is the government struggling to save it? And why didn’t $40 billion do the trick? Can they buy back the yen at $40 billion every single day? Is that sustainable? I think not.

Every action has a reaction and loose monetary policy is a good example of this. For a long time now, Japan has had the lowest interest rates in the world. This has made the Japanese big foreign investors. It made sense for the Japanese to hold their savings overseas, particularly in foreign bonds. With their $1.1 trillion in U.S. treasuries, half trillion in Euro bonds, and international real estate, it is estimated they have about $4 trillion total in foreign assets. Also, low interest rates and stability in the yen made it the world’s currency of choice for carry trades.

In a carry trade, there is a lot of money to be made. It’s a form of gaming used in financialization where an investor borrows in yen for virtually nothing and puts it into bonds or saving’s accounts in another currency which yields a higher interest rate. It can be risky, if currencies move against each other, but it’s generally been a highly profitable trade with the yen. Now, however, things are changing. A few moths ago, the Bank of Japan raised interest rates for the first time in seventeen years ranging from 0 to 0.1 percent. Finally, after a long deflationary period, the nation is starting to see inflation.

Will Japan need to sell its U.S. Treasury holdings to save the yen? What would this do to the U.S. dollar? If it tanks the dollar, which selling would likely do, will the Fed continue to raise interest rates? Will they buy the bonds that nobody else wants? If they can’t, then what will they do to encourage Americans and the world to buy them? As the currencies pick up speed on their trajectory to zero, we will see lots of things breaking, and a pileup of wreckage. In the end, bonds will go worthless, but that might take awhile. I’m not sure how long it will take for the world to get gold back into the center of the system, but I sure hope they figure it out soon.

Circular motions are systemic and infinite, as is nature. Old people die and babies are born. Old trees dry up and new ones shoot up from the earth. Hurricanes and tornados wipe out neighborhoods and all the greenery comes back. I think of the seasons and how critical they are in the circle of life. Civilizations collapse and new ones emerge also. Our monetary system is dying and a new one is emerging at the same time. This is the cyclical process of nature. It’s called reproduction, regeneration, recycling, etc. You may have noticed that in 2023, Japan had just 7 births per 1000 people. It has been declining about 1.3% per year. They’re at risk for losing their ethnic heritage because they are on a linear path.

Linear motions are pervasive and they always end at some point. Shooting stars or meteors, which travel along a continuum, eventually burn up in the atmosphere. However, once in a while a meteor is large enough that some of it manages to crash into Earth’s surface as a meteorite. In analogical terms, I would equate this to World War III breaking out. Will the currencies burn up? Will they go back to orbiting around gold? Or will the sheer speed and force of hubris result in conflict and a crash which destroys the human race? Nobody knows, so let’s make the most of life in the meantime. But keep your eye on Japan.

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