Japanese Yen weakness promises rosy future for ailing economy

In the last week there have been some positive signs from Japan. The Liberal Democratic Party (LDP) has been able to form a government, in the process resulting in Shinzo Abe being able to launch a new policy direction. His direction is very good, because it offers business some concessions, a loosening of monetary policy, to offer exporters a more competitive exchange rate, as well as funding for the rebuilding of the Tohoku area. The devil of course will be in the detail, however the signs look good.
Understandably the exchange rate has weakened. This should be enormously stimulatory for the country, and I suspect it will be sustained by the strength of the Asian region. This might well be the lead the market needs in terms of dragging the globe out of this slump. Japan needs to rebuild real incomes, and that will come from exports to Asia as well as deregulation of the high-cost Japanese economy. Japan has no choice. The people are already killing themselves with work. They need a lower cost environment. The concessions so far have come from workers in the form of outsourcing, contracted labour agreements which mean many workers are easily fired. This is not to ignore the fact that Japan retains high cost 'life of employment' workers in the large companies. That culture will need to change. We can look forward to a dynamic Japanese economy. Historically transformations have been rapid. Remember that Japan is the compliant society; so expect people to fall into line. Few cultures have such acceptance of personal hardship; so much tolerance for austerity than Japan. It will happen again. I would be expecting to happen quickly, as it did in the Meiji and post-WWII era. One needs only look at the discipline of the Japanese homeless people.

The Yen has alread weakened somewhat; but as is apparent, this is a medium term exit point as Y90 is an important resistance point....as you can see from the chart. You might expect a resumption of Yen strength to Y84 in the coming weak, as traders take profits. The evidence still needs to fall on the table.
USD-JPY EXCHANGE RATE - as at 22nd Jan 2013.

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AUD going upwards from here

This economist is forecasting a fall in the $A below 0.90c. I cannot for the life of me see this happening in the context of the current market. I'm all for global cooling; but I don't see 'hell freezing over'. Basically the outlook for Australia is very good. Why?

1. The global economy is entering the 2nd stage of a super-cycle after debt levels ran up to historic highs.

2. The debt crisis will disappear and we will have a consumption spurge by these emerging markets, once confidence is restored. This will see debt levels balloon in those countries which have low debt levels. i.e. China, etc. So this will bring about a re-balancing

3. There will be drastic changes in the way Western business operates. They will be forced to move offshore, or drop their high-cost structures with head offices and outsource to households. High margin businesses and senior executives will stay in the office, others will go to cubicles in the suburbs, if not work from home. Why? Because there is a disparity in wage-productivity which will need to be closed, because the West will not be able to afford their welfare states. 

What will see the AUD hold this 98c level is:

1. The very positive outlook for its commodities

2. The very favourable exposure to iron ore, coal and oil & gas

3. The resource rent - it will mean more money stays in Australia; less dividend outflow; but it will be wastefully spent by government. Better waste or opportunity cost than dividends you might argue....assuming Gillard did us no harm on the sovereign risk ratings. Truth be told, she made it better because she showed that the developing world was worse than the West, i.e. She allowed them to drop their ball by lowering the bar on sovereign risk. Yes, blame Gillard for the global rise in taxation/expropriation - she sanctioned it first. She changed the trend. 

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Andrew Sheldon www.sheldonthinks.com

New European currency bloc needed

In March 2010 I penned a blog article suggesting that the southern European countries - Greece, Italy, Spain and even Portugal - which are struggling with high debts - should form their own currency bloc. Its gratifying to see Warren McGibbin, director of the Reserve Bank of Australia (RBA), draw the same conclusion. You can read his justification here. Might I suggest a name for this new currency - the drip - to acknowledge the 'slow leak'.

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Andrew Sheldon www.sheldonthinks.com

The emperor has no money

Have you heard the one about the 'emperor having no money'. It is a variant on the theme of 'the emperor with no clothes'. It highlights the moral relativism or 'monetary rationalism' that goes blistfully unawares in the largest economies in the world. Consider these facts:

1. Most of the world's financial resources are denominated in USD, EUR or Yen

2. Most of the world's wealthy people are located in those countries as well.

Monetary authorities in these countries need not draw attention to their economic malaise if they all sabotage their economies in the same stride. i.e. The Japanese have a bloating public debt of 220% of GDP, Europe has the indulgent southern and northern states to support, whilst the US has its twin deficits. Now, these countries account for so much of the global wealth base, that if any large public or private holder of these cuurencies decided to do anything, what difference would it make? The 'rest of the world' is too small to account for significance.

The implication is that currencies like the Australian, Canadian dollars, South African Rand, etc can become priced very high in USD terms, and these currencies will remain in-sync, and thus relatively attractive by virtue of the size of these economies. None of the monetary authorities will question the strength of these commodity currencies.

So what is the next step? The problem is that these 'strong' currencies will be forced to sabotage their economies too so that their currencies weaken. After all they have to remain competitive against the major currencies....otherwise they will simply become miners of commodities, which employs only 3-5% of any labour force directly. Clearly they are not going to allow that. So expect commodity producers to sabotage their economies, i.e. Expect them to increase taxes and welfare, so that a greater piece of the cake goes into unproductive welfare. Expect them to keep interest rates artificially low to drive their currencies down.

This is where perceptions become more important than facts. That is why the 'emperor has no clothes'. People care not about the reasons....so long as the illusion of comparative advantage or the illusion of wealth is preserved. In the meantime, the global wealth creating potential of the globe will be sabotaged. Collectivists around the world can rejoice....they are extending tyranny to the strongest nations in the world. The good will be forced to discard financial discipline. Morality or fiscal responsibility will become irresponsible or impractical by this standard of value. Welcome to the contemporary system of public administration. It was always there, you just didn't see where it was taking you. It gets worse...are you going to wait for worse?

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Andrew Sheldon www.sheldonthinks.com

The AUD will continue strength - $1.25 anyone?

You might wonder for how long can the AUD exchange rate sustain its strong rise against the USD. I would suggest that it can do it for a while yet. We might think that the strong $A is going to jeopardise our international competitiveness. The reality however is that:

1. Until recently, the USD was being debased more than the AUD was rising. This is evident against other currencies such as the Philippines peso, a strong Asian market, which is not a significant commodity exporter. It should be, but corrupt/failed state impacts its prospects.

2. The AUD is benefiting from stronger commodity prices, but alas they have tends only to strengthen because of a weak USD, which most commodities are denominated in.

3. The Australian economy is such a commodities export machine sitting on the door-step to Asia, so there is good reason to expect strong export income growth, as well as strong business investment.

4. Australia is a net oil exporter. We must remember that whilst Australia produces little oil, i.e. about 60% of its needs if I recall correctly, it produces a hell of a lot of gas, and conventional and liquefied gas is priced based on an oil reference price, i.e. If there is a Middle East crisis, a lot more energy dollars is coming to Australia. Mind you some of it will be flowing out again as dividends to US, European and Chinese/Japanese/Korean equity partners.

5. These strong exports is driving more investment, which leads to capital inflows, i.e. strong $A.

6. High local indebtedness: The Australian private household is well-geared to property. The Reserve Bank is going to keep interest rates low so that people keep spending. i.e. It wants people spending as much as possible because the domestic economy will be a little weak...mind you unemployment is pretty good. But people will not be confident about the external world. But interest rate rises will probably depend on if housing turns into a bubble...so there will need to be some increases in prices coming...to cool that market.

It is true that tourism will be hit by a strong AUD, and the government is clamping down on immigration growth. We can also expect some weakness in the broader market thanks to weakness in property. A little weakness in the broader domestic market might actually help to curtail spending. Fears of inflation, problems in the Middle East and the US economy also help.

For these reasons....I think the currency will stay strong.

I just don't see anything negative on the horizon. I don't see China collapsing. High oil prices will hurt Asia more than Western markets, though its probably tensions in the Middle East will probably not impact oil production.

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Andrew Sheldon www.sheldonthinks.com

Australian dollar lives up to expectations

For a number of years I have been very bullish on the Australian dollar. The reasons are clear for a person with an understanding of currency markets and mining. I have both. So when you witness the activity going on, and you read headlines like the following - one becomes sharply optimistic:

"HSBC estimates the total value of Australian mining and resource projects proposed or under construction at $777 billion, or about 60 per cent of gross domestic product".

The implication of this is that in a few years there is going to be mining operations contributing about $150 billion in wealth to the Australian economy, i.e. about 15% of GDP is going to be added to the Australian economy. We need to be careful here because:

1. Not all these projects are committed

2. These are capital costs - but we might expect conservatively a 4 year payback on these projects

3. These projects will have variable mine lives, anywhere from 3 years (for smaller gold mines) to t0 20-30 years for a gasfield, to 50 years (for iron ore mining projects)

4. Resources are still being discovered

5. Mineral prices are still rising, and can be expected to keep rising so long as the global labour market place keeps liberalising.

6. A mining project can take anywhere from 2-10 years to commission.

Based on this information, we might expect around half of this investment to be earning export dollars in the next 3 years (i.e. 25% of 30% of GDP) offering 7.5% growth in GDP. i.e. Mining is adding about 2.5% growth to GDP. But then we need to acknowledge that this is just part of the economy, and this ignores the capital inflows to fund this investment.

This is why it is good to be Australia. Well actually there are a lot of reasons. In fact, I can only think of one bad one. We have a government - 2nd only to Mussolini in terms of is fascist foundation for governance. Australians are unwittingly vulnerable given they are just basking in jobs, high pay and excess sun.

This is obviously a problem because people will start spending, raising foreign debt levels, people will stop working, reducing workforce participation, and thus economic efficiencies tend to creep in. That is when government starts importing labour...which brings you to Australia. The land of milk and honey..and bad government. A miners paradise. Clearly there is some vulnerability to global events; most particularly global metal prices. I actually think we can expect some vulnerability as a result of an oil price spike in the Middle East, as revolutions broaden in scope.

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Andrew Sheldon www.sheldonthinks.com

USD-JPY set to weaken

The current chart for the USD-JPY is strongly suggesting a fall in the USD back to 80yen. The USD has struggled to break out of the current trend, and we expect it to fall back to that support. This is the short term price action, though we do believe that the medium term outlook for the USD is stronger than for the JPY. The Democratic Party of Japan (DPJ) has allowed its fiscal reform opportunity to slip away with in-fighting over leadership. It is therefore expected that any sign of reform is at least a year away; perhaps under a new prime minister and some reinvention of the LDP.

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Andrew Sheldon www.sheldonthinks.com