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Rush to dollar assets costing Japanese investors dear

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By Hideyuki Sano and Yoshiko Mori

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Because returns on domestic products are so low, foreign-currency-denominated stocks and bonds are popular among Japanese investors. Their need for dollar funding is pushing up the cost,” said Makoto Noji, senior fixed-income strategist at SMBC Nikko Securities.

If the return on domestic products are so low why is the NIKKEI stock index rising over the 20,000 yen mark?

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If the return on domestic products are so low why is the NIKKEI stock index rising over the 20,000 yen mark?

Probably for the same reason my Miami home quadrupled in value from 1998 to 2007. Low interest rates and easy lending policies caused people to invest in the housing market, driving up prices beyond a reasonable and sustainable level.

Now the central banks are doing essentially the same thing commercial banks did during the housing boom, lowering interest rates almost into negative territory, which allows companies to borrow cheaply, then invest what they borrow in the stock markets, which drives up the price. The stock market has doubled in the last three years, even though domestic sales have been flat, exports have increased very little, and GDP has barely risen.

The companies that hold these stocks know they are considerably overvalued, and are either holding onto their returns in the knowledge that eventually the market must fall, or are doing as the article states, and converting their holdings into dollar assets.

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@Yubaru,

If the return on domestic products are so low why is the NIKKEI stock index rising over the 20,000 yen mark?

The short answer: buying stock in the Nikkei in yen has been great, buying stock in the Nikkei in dollars has been good too, but changing yen to dollars and then buying Nikkei stock is way better.

The long answer: The yen-carry deal (aka dollar swap), which was popular throughout the 2000s, helped fuel the 124/dollar level in back in 2007 (also a time when world stock markets were reaching the height of their pre-recession bubble). Simply put, it meant borrowing yen at low rates then converting into dollars and investing elsewhere (like US stock/bonds) as practically anything paid interest more than the interest charged in Japan for those yen loans. This was a very open secret, which made it even safer since the only downside would be if the yen gained in value, but with so many people/institutions jumping in to do the yen-carry, as more yen was converted out to foreign currency, the more value the yen lost. So it became a double win (higher interest abroad, declining value of what was owed in Japan).

Then the crash of 2008/09 hit, so when people sold off their investments they also paid back their yen loans, which meant an influx of foreign currency back into yen, which increased the value of the yen, which in turn made more people re-pay their yen loans, and within a year or so the value of the yen skyrocketed from 120/$ to 80/$. There was so much converted yen out there that when it all came back, even in midst of a major recession, that Japan -on paper- was somehow rich. The yen was strong because people needed to repay the loans they took out, not because it was considered a "safe haven" as the news liked to report. (remembr how the yen increased even further with th earthquake/tsunami? Japan's economy wasn't safe, that was because even more money needed to be converted from abroad into yen to pay off massive insurance claims.)

It took a bit of time to regain some steam (world interest rates have become as low as Japan's), but the yen-carry has been back for the past 2 years with the advent of Abenomics. Borrow at low interest, convert it out of yen, and collectively drive down the value of the yen by doing so (especially when the government is on a well known money printing binge), then take an additional profit (aside from the foreign investment profit) off the declining value of the yen. Its not even an open secret anymore as both Aso and Kuroda have been blaming "speculators" for the rapid yen decline (Japan hasn't printed that much money), for they know the yen is not taking this current value due to the 'soundness' of Abenomics. And its just a matter of time (probably sooner than later) before a single chip in the world market makes some people need to go liquid and re-convert to yen to pay back their loans. When the amount re-converting starts outnumbering those converting out, then the yen will gain value, which in turn will make more people re-convert, and like a snowball down a mountain the money will flood back into Japan. So today's 123/$ and 20,000Nikkei is all based on a get-rich-quick scheme where the more players there are, the richer people become.

Back in the 1980s the yen gained value along side the Nikkei. But now, everything is upside-down here. Just compare the J-economy to anywhere else on the planet: high value of stock with falling value of currency, then low value of stock with high value of currency. Those two should operate together, not conversely. This should not happen with a major world economy. The richer Japan becomes the poorer it becomes.

Investors know this, companies and banks know this, the government knows this. The yen has become the sacrificial lamb. So its no wonder that J-companies don't want to increase their wages. The increase in salaries is a long term obligation and not something to be held to when all the current profits are the result of an obvious bubble of speculation that is doomed to pop.

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“Because returns on domestic products are so low, foreign-currency-denominated stocks and bonds are popular among Japanese investors. Their need for dollar funding is pushing up the cost,” said Makoto Noji, senior fixed-income strategist at SMBC Nikko Securities.

Meanwhile the average stiff just keeps blindly depositing money in their Japan Post savings account and earning basically nothing, so the government can turn around and borrow it at near zero interest. And, of course, while it would be in these folks' best interest to possibly invest in foreign-focused mutual funds, or the like, that won't happen. One, because the government cannot afford it to, and, second, because the Japanese people are too risk-averse when it comes to investments. So, as usual, the top 1% i

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When the dollar does pop the cradle will fall. 5.4.3.......

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Thank you for the explanations!

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@Kobe White Bar Owner

What would be popping? Japan has way more problems with the distortions caused by socialism than the US.

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@Supey11

Excellent post. So what do you predict for the future, concerning the value of the Yen?

I must admit I'm one of those who made bundles of cash of the NZ$ at Y50 and am about to make even more on the US$1 at Y80. I'm thinking of taking my profits and running because the Yen is due for a steep rise.

If Yellen doesn't raise interest rates by the end of this year and Kuroda will not be able to continue with the present QE after 2015 because quite simply there will be no more domestic debt available for the BOJ to buy and buying foreign assets will be accurately seen as currency manipulation.

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Gary,

I have been buying back some yen recently, but only because I have plans to actually use the money shortly.

But the 122ish level currently marks the top of a multi-decade downtrend in the dollar/yen, which is in the process of being broken.

No one can rule out a period of yen strength, but

If Yellen doesn't raise interest rates by the end of this year

I think she'll probably start, but in any case, the US is on a different path to Japan.

Kuroda will not be able to continue with the present QE after 2015 because quite simply there will be no more domestic debt available for the BOJ to buy

Indeed they may have troubles executing their policy, but the flipside of the BOJ owning so much government debt also poses risks for the value of the yen that the BOJ issues.

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@Gary If the US raises interest rates soon, as is becoming more and more expected, then the yen will not be going up to 120 again anytime in the near term, as higher US rates is a perfect combo for the yen-carry scheme.

That said, Mrs Watanabe (the name for independent and amateur Japanese FX traders) sees this current drop past 121 as a big signal to buy dollars as it's considered a peak point. And the Nikkei is starting to hurt for more capital, as can be seen by the fact that they are giving out the biggest dividends in years in order to woo more investors.

But Kuroda is still intent on the 2% inflation target and has not said anything about this being a yen bubble (he actually just said it is specifically not a bubble). But if you hear the BOJ say otherwise then the yen may turn, however its also widely expected for the printing presses to continue here for the time being (they kind of have to to continue with the asset supports they've bee giving, for like any good addict, the bond and equity markets can't do without it now).

But now I just started to wonder... bubbles are for when things are overvalued. But the yen is in realm of being undervalued. So of course this can't be a bubble. But then what is the opposite of an inflating bubble? All I can think of is a black hole, and somehow that seems like a fitting description of the Japanese economy -a place where the normal laws of the universe cease to be predictable. .

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@ fxgai and supey11.

Thanks people for your posts,

I think I'll cut and run this Friday. 33% profit margin on a 3 year investment will do me fine.

If the Fed does raise interest rates, as you both seem to imply, it's the Indian Rupee, a month after that rise, as my next investment.

The South African Rand would be my first choice in a political stable environment, but...... a future Zimbabwe...

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In this world, there is something called "No free lunch".......

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I think I'll cut and run this Friday. 33% profit margin on a 3 year investment will do me fine.

Don't forget to pay your tax next year!

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Several good posts here. Thanks Supey. Yes, definitely some kind of wonky bubble. Doesn't bode well, especially not for the average Joe.

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Excellent posts, Supey. My hat is off to all of you who have made money off Abe's disgusting wealth-looting scheme -- I myself was able to rescue $50,000 at 87 yen in early 2013, but the vast majority of my wealth is in yen savings accounts, being destroyed daily by inflation and devaluation. (I work in the finance field, and as an employee cannot open an account anywhere else, but as an American cannot trade using my own firm, which bans Americans. So it's all-cash for me.)

Can't invest, can't borrow (no permanent residency). It's like watching your own house go up in flames armed only with a little water bucket.

With a strong yen and steady consumer prices, I felt so confident about everything back in 2012. Made a respectable salary, my savings was growing... then Abe and the LDP came back to power. Even in 2013 it didn't look like things would ever get this bad. I can't believe they've been allowed to destroy their currency like this. As I've said before, the only thing saving Japan from total ruin is the low oil prices that we're now seeing. Next time oil hits $100, consumer prices will zoom upward. Abe and Kuroda will cheer and the common people will suffer. But seemingly half of them have already been brainwashed to think that this suffering is good for society.

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@Supey11

You put too much importance on the carry trade. It's a factor, but one of many. The overiding fact is that gobal investors simply like the yen for its liquidity and it's backed by a safe, stable, dependable economy. They like the dollar for its returns and that it's backed by the world's no. 1 economy.

So when they feel bad about the global economy, they pile into yen, driving it higher. When they feel optimistic/confident, as they do now, they buy dollars. Dollar goes up -- yen goes down. that's why the yen was safe haven even as fukushima was spinning out of control.

That still makes the yen a safe haven currency. If the global economy were to go sour again, we can expect the yen to climb again, all other things being equal.

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@ThonTaddeo

and as an employee cannot open an account anywhere else, but as an American cannot trade using my own firm, >which bans Americans.

This is the quintessential "living in Japan" experience....

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