Tuesday March 8, 2005 - 11:25:42 GMT
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Black Swan Capital - www.blackswantrading.com
Dollar bias negative - for now
“Markets no longer appear in the entirely rational, well-behaved patterns of past financial theorists. They are seen for what they are: dynamic, unpredictable, and sometimes dangerous systems for transferring wealth and power, systems as important for us to understand as the wind, the rain, and the flood.”
Benoit Mandelbrot, The Misbehavior of Markets
Watanabe-san is back in the game, warning that Japan will intervene when necessary. This “warning” seems a lot more to do with the Japanese economy than it does about foreign exchange values. Japan realizes its economy lost a whole bunch of much needed monetary stimulus during its FX intervention hiatus. So, what better way to use that little stash of currency reserves than to help keep the economy from being wheeled back into the intensive care unit.
As Stratfor (www.stratfor.com) so succinctly stated it:
“Japan spent most of 2004 proudly droning on about how its economy was doing fine, just fine, thank you, and about how it was finally emerging from its seven-year deflationary spiral, despite the fact that the government had yet to implement a single meaningful policy to resolve its bad loan crisis, its state debt crisis, its local debt crisis, its corporate debt crisis, its consumer spending crisis, its deflation crisis, and so on. Stratfor, recognizing the extent of Japanese wishful thinking, scoffed at these claims.”
This helps explain why Japan is one of the few Asian central banks that didn’t reallocate reserves out of the buck. They knew they’d put them to good use.
After regaining some ground yesterday following Friday’s job news shellacking, the dollar is drifting lower again. We could quite easily see a retest of Friday’s lows—and more—as dollar sentiment is fading on a host of reports in the market: The BIS Asian bank reallocation report, the IMF report which praises US growth then warns (The IMF raised its outlook for U.S. growth this year and next to 3.7 percent, but cautioned that "with household savings close to zero a retrenchment in private consumption remains a risk, particularly if house price increases were to slow.") and of course the looming US trade deficit report due out on Friday.
Other than the deficit report on Friday, the other two reports referred to above are nothing new. But, no one said that markets were always, I would say “ever," rational. As Mr. George Soros wrote long ago in his book Alchemy of Finance:
“To the extent that exchange rates are dominated by speculative capital transfers, they are purely reflexive: expectations relate to expectations and the prevailing bias can validate itself almost indefinitely.”
In other words, no matter how I opine about relative US economic strength and rising US interest rate yield differentials, if the market is biased in against the dollar, the real world events don’t matter.
But, Mr. Soros had more on this:
“…The situation is highly unstable: if the opposite bias prevailed, it could also validate itself.”
So, let’s say on Friday the trade deficit shows improvement, instead of the expected deterioration. Better yet, let’s say the deterioration is less than expected (we saw on Friday how market’s can react when expectations aren’t met). Maybe this would be a catalyst for a “flip-flop” in bias and a strong dollar is validated. (That’s not a prediction, just an observation.)
And the finale from Mr. Soros:
“…The greater the relative importance of speculation, the more unstable the system becomes: the total rate of return can flip-flop with every change in the prevailing bias.”
Hot money speculation, juiced by massive central bank liquidity injections, in search of yield and growth IS increasing the relative importance of speculation, I think.
Maybe Mr. Watanabe-san knows something we don’t.
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