US Government bond holdings fuel Bank of Japan suspicions

Currency markets spent a large part of this week speculating about the size of reported covert intervention by the Bank of Japan.

The dollar fell to two-year lows at Y115.1 on Monday before jumping sharply to more than Y116. The steepness of the move sparked speculation the BoJ used enormous sums in its bid to stem the yen's appreciation.

Although the bank has not commented on any action in the market, traders and strategists believe it could have sold more than Y1,000bn ($8.6bn) on Monday alone and about $20bn (Y2,350bn) this month.

Data this week supported the market's suspicions. Weekly custody holdings data from the Federal Reserve showed official holdings of US government bonds - a proxy for overseas central banks' holdings - rose by a massive $20bn in the week to May 21.

"If the holdings jump around like that you can pretty much bet that reflects the 'active' central banks," said Tony Norfield, head of foreign exchange strategy at ABN Amro. "It looked as if the BoJ had used $10bn [in intervening] and it now looks like they spent much more than that."

Mr Norfield said the jump could reflect some dollar buying by other central banks, but the majority was probably BoJ-related.

The bank began covertly intervening in the market in January and spent nearly $20bn during the first three months of the year. It held off in April as the dollar stabilised and the euro reached four-year highs against the yen, taking pressure off the dollar-yen rate.

But in spite of the euro's new highs this month, the US currency's steep slide is likely to have prompted the bank to act again.

The dollar ended this week near Y117 as a result of the BoJ's actions with speculators, hurt after Monday's sudden reversal, unprepared to test the bank's resolve again. The euro marched to a succession of highs against the yen, peaking at more than Y138 yesterday. Against the dollar, the euro yesterday reached a post-launch high of $1.1808, comfortably surpassing its 1999 launch levels.

Interesting. Wish I could say I understood more than I do about the whole internation currency game.

My thought is that we are driving down our dollar so as to make the spectre of deflation not show up on our own reports. That is even if we are having deflation if the dollar itself is worth less at roughly the same rate than since the reports are all valued in dollars it looks as if we are flat instead of going through deflation.

But like I said thats just my thought. I could be completely out to lunch on this one......

Look at it this way.
Bush wants to get reelected, so like any good politician he tries to spread around cash from federal spending, aka pork. (That is of course your money that you send to DC.)

Well, when he's done with that he wants to spread more around. So he has Sec. of the Treasury Snow talk down the dollar. By so doing he hopes to raise exports from the US and give employment and money to places like Pittsburgh.

So, the net of that is that with the dollar weaker every family has to spend more on that portion of its goods and services that come from outside the US.

So under the first method, you send a check to DC which he sends to vote rich areas. Under the second method, he makes you send more of your [lower valued] money overseas so that more cash flows to vote rich areas.

I suspect you are at least partly right. For years, the Bank of Japan has begged the U.S. for help in coordinating policy against the Chinese Renbei, which is pegged to the U.S. dollar.

And for just as many years, Greenspan and the Federal Reserve cabal have been loathe to stem the stampede of American investment in and cheap imports from China, lest their globalist masters complain.

However, with the growing national debt and the Japanese preference to park their excess capital in America versus some other country, makes a closer partnership absolutely essential. In fact, this may have been the Bank of Japan's demand this time in return for massive dollar buying. Buying a falling currency otherwise makes no sense.

Buying a falling currency otherwise makes no sense.

I'm no expert, nor do I play one on TV. However, at least one of the greatest export competitors to the Japanese is the Chinese. As was pointed out, the Chinese Yuan is tied to the US dollar. If the US dollar falls against the Yen, or the Euro, or the Australian dollar, the Chinese Yuan falls by the same amount. The US dollar was falling against the Yen, and the Japanese exporters were screaming bloody murder, so the BoJ purchased huge amounts of US government debt to prop up the dollar's value, at least vis-a-vis the Yen, to reduce the Yen's strengthening against the Yuan. My 2 cents.

Currency trading is really very straightforward.

Of the 3 majors, USD, EUR, and JPY, at any given time, one is weak, one is strong, and one is somewhere in-between. The stronger or weaker a currency is, the more that the current trend tends to persist.

USD is terrifically weak against EUR right now, and neither Dim Wim and the Bulbs (that's Willem Duisenberg, lame duck head of the Euro Central Bank, and his flunkies) nor Snowboy (our 'esteemed' SecTreas) seem inclined to try to change the situation. ECB just passed on an interest rate cut during the past week.

JPY right now is the currency in the middle. Koizumi and the BoJ/MoF crowd are busily posturing (h*ll, they've been doing that for years) as to whom has the right policy (haha) to end the deflationary spiral in their country. They loathe the idea of JPY getting stronger against USD...but they probably can't stop it.

If you ever played cards with your friends when you were young, you understand the game. It's simply an enormous game of 'Pass The Trash', otherwise known as 'Screw Your Buddy'.

Currencies are nothing more, these days, than a unit of account, each manipulated by its issuing gov't, in an attempt to gain an advantage over the nation's trading partners.

Too cynical for you? Hard lines. That's the way it is.

The winning position? No such thing, over all the time.

The winning TACTIC? Ah, that's easier.

I directly noted that strong currencies tend to persist in strength, and weak ones in weakness. Not joking around at all.

Just now, in concordance with this view, I'm long a good deal of EUR/USD (preferring the Sept CME/IMM futures to an interbank forex position), with a number of very short-dated (expiring June 6) out of the money call options written against the position.

Nothing's perfect, of course. However, if EUR does anything but crash, say 500 pips over the next 9 trading days, I will have made a tidy profit.

Attempting to predict intra-day and intra-week movement in currencies is enormously difficult, and I've no intention of trying. In any case, what information I have about sundry gov't policies regarding currencies is, by defintion, far inferior to the information other large mkt participants have. Why try to 'outsmart' them? What a mug's game that is.

Central tendency in the outright position, and time decay in the options position, are the two greatest allies that a currency trader can have, and can put regularly on HIS side in most trades.

If I had no position in Euro just now, I'd certainly write the ECM (June Euro) 115 or 114.50 put options, straight out, pocketing about 6% net on capital in the remaining 9 trading days.

Best wishes, FReegards, and Happy Memorial Day!

One other thing, mate.

In terms of trading, there IS NO MONEY, ANY MORE: CURRENCIES AREN'T MONEY, in the sense of the classical economic definition (medium of exchange, storehouse of value, unit of account). Currencies are these days exactly just like soybeans or copper or orange juice; they are commodities. That, and no more...and they should be traded accordingly.

Naturally enough, currencies aren't necessarily affected by the same factors as affect cocoa or wheat or silver, and a good thing, too. Weather (said he, naming only one factor) changes day-to-day and week-to-week; gov't policies and broad macroeconomic situations do not.

Not trying to be obscure here, at all -- just don't know what information might be most useful to you. (sorry!)

That's a trading perspective (which helps), but what I think we're trying to understand is a more macro economic perspective.

For instance, right now the dollar is the weak currency-- what that means for U.S. consumers is imports become more expensive while U.S. goods become competitively priced, for U.S. producers is export sales go up along with domestic sales. So this would tend, in time, to create stronger U.S. business profits, more U.S. jobs, smaller trade deficits, and an improving economy overall. The short-term pain to the U.S. consumer should be offset by the improving economy overall. Right?

Meanwhile, the Euro is the strong currency, and since they're already having economic problems, they're really going to suffer, and there's not a whole lot they can do about it.

Anyway, I don't know to what extent these currency fluctuations are orchestrated by central banks and to what extent they're purely market phenomena, but years of observation leads me to believe that imbalances work themselves out over time.

Sorry; I was unclear in my question (although I appreciate the answers, of course). I'm not into trading currencies. What I mean to ask is, is it generally a good thing for the U.S. economy for the dollar to be strong, or a bad thing? Or is that a variable, too? Or are they totally unrelated?

Thanks again for your patience with someone who really doesn't understand all this monetary stuff at all.

That was a nice concise summary of the international business cycle, or at least how it has worked in theory since the collapse of Bretton Woods in the early '70s.

But, as usual, actual practice diverges from theory most of the time. Central banks do, of course, try to game the system -- the Japanese, historically, have been utterly shameless about doing so; these days they're considerably more low-key (witness the 'stealth' intervention in Jan-Mar of this year to keep JPY from popping much higher vs USD). The power of central banks is considerably overstated, though. When the political types do something sufficiently egregiously stupid (e.g. the British adherence to an ERM -- the precursor to Eurocurrency -- that become completely unworkable after German reunification in 1991), a central bank can no more stop the inevitable crash-boom-bang than King Canute could halt the tide.

Add to this factor the next one, that central banks don't always get things right (again, witness the refusal of ECB to cut rates, both this past week and generally this year...notwithstanding that Wonderland (my name for the Eurozone) is staring recession in the face), and you have a recipe for all kinds of fluctuation in currency rates, much more than one would expect from theory.

Always remember that investors and traders have gigantically more total capital than any central bank, and, as a class, are not about to accept the most convenient bits of hokum and nonsense uttered by either central bankers or (especially) politicians when their policies have put one or another currency under the gun. When CBs and pols HAVE tried this, the currencies involved have been simply destroyed, and in very short order. Fortunately or not, these creatures seem to be finally learning this fact, at least to a limited extent. It's possible that their acceptance of this fact will devolatilise foreign exchange rates in future...but I'm not holding my breath on that one. :^)

FReegards!

Brandon -- Good thing? Bad thing? My thoughts on that can be found at:

DOLLAR CREATES POLITICAL UNREST IN EU COUNTRIES
Posted by SAJ to Claire Voyant
On News/Activism 05/23/2003 8:38 AM PDT #11 of 18

It's really too bad that many people believe that currencies are more complex than they actually are. Schools simply don't teach the basics of money and foreign exchange, which is by itself both hilarious and tragic, because we all use money or money surrogates essentially every day of our lives.

Two things to remember, that might help a bit. 1) Currencies are PAIRS -- there is no such thing as the value of a dollar (or USD as we call it), there is only the value of USD versus some other currency, EUR, GBP, JPY, CHF (Swiss Franc), or whichever. 2) Currencies are in many senses just like fruits at the grocer's; sometimes the price of oranges is low relative to the price of cherries, but, when cherries are in full season and the supply has risen, the reverse is generally true. Therefore, in theory anyway, one could make a nice little profit by anticipating this shift in the relative value of the two items. Same thing in currencies, really, except that in the one case a trader will be watching the size of the cherry crop, and in the other the size of the dollar 'crop', i.e. GDP, money supply, and similar measures.

Hope that's of some use to you, and FReegards!

In a recent Economist magazine they state that the Chinese Yuan was possibly 50% undervalued to the U.S. dollar. Historically, currencies with the highest economic growth and a large trade surplus have appreciated. Therefore, it would seem that the Yuan is a good currency to diversify into out of the dollar. However, it is supposedly not readily convertible at this time.

Does anyone have any idea of how you could gain Chinese Yuan exposure (bonds, etc.) or possibly accomplish the same thing by investing in a proxy of the Yuan? (Taiwan, Hong Kong, etc.?).

As a general thing, you can't -- or at least not directly. It's not only not 'readily' convertible, outside of international contracts approved by the PRC government, it's not convertible at all. (Well, I suppose you can exchange USD for RNB with cabbies and desk clerks and so forth).

Taiwanese dollar is not a surrogate for renminbi; Hong Kong dollar is maintained by PRC as an economic convenience, to accommodate pre-existing contracts. I haven't tracked its performance vs. USD since the 1997 takeover, sorry (I've lived in Communist nations -- rule 1: do not do business with them unless you're simply TOO big for them to screw over like, say, IBM; rule 2: see rule 1).

Also, foreigners aren't allowed to directly own shares in PRC companies (which would be the obvious way to bet on an appreciation in RNB). One has to jump through some number of hoops to do so, and, frankly, I don't know what those hoops are, these days.

Be advised, though, that if you do seek ownership of sundry Chinese shares, there is absolutely ZERO transparancy in their stock markets and regulations.

Here's something worth trying: I have, on occasion, e-mailed questions to various folks on The Economist and have received a rather surprisingly high proportion of responses. Might as well have a go -- the price is certainly right. Might try South China Morning Post, as well.

No matter what, though, you'll have to be patient. PRC has no intention of making renminbi convertible any time soon.

FReegards!

One cut certainly won't stabilise anything. In fact, it would likely make fx rates even more volatile in the short term. What appears to me to be necessary is a policy shift on the part of ECB, establishing a bias toward lower rates generally. That's the good news.

The bad news is that this is probably impossible for 6 months, maybe a year. Dim Wim is the lamest of lame ducks; he can't credibly push for a policy shift now. His successor, probably the ultra-crooked Trichet (but it will be some froggie jerk in any case) has spent most or all his political capital fighting to avoid a long, long stay on the Ile de France, and so is in no position to exercise leadership on this matter. Not that he likely would; the froggies don't think about interest rates in the way normal people do...and, anyway, they're too busy planning their vacations (it's almost June, after all).

Add to this mix the assorted budgetary and deficit maintenance requirements of Maastricht, and you've a very nice formula for doing nothing. Fine with me -- Wonderland economies will pay a HUGE price for standing pat, I'll make a few bob (or more than a few) trading on their stupidity in the meantime, and the sun will shine very pleasantly. :^)

This sort of thing, btw, is why I much prefer longer-term trading strategies over short-term swing trading. Once the trader has the **actual** orientation of the CBs in hand (as opposed to the 'jawbone' orientation), he need do relatively little work to keep a profitable position profitable for some considerable period, occasionally for the best part of a year. EUR/USD may stabilise shortly, or it may not, but what it won't do any time soon is reverse sharply in USD's favour.

FReegards!

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