YEN JUMPS TO TWO-MONTH HIGH ON JAPANESE APOLOGY AND GREENSPAN COMMENTS ON THE YUAN -- WHY A HIGHER YUAN MIGHT NOT BE THAT GOOD FOR THE U.S.
JAPANESE APOLOGY BOOSTS YEN... Over the last week I wrote about the U.S. Dollar starting to roll over from its 2005 high and its 200-day moving average. At the same time, the Euro was bouncing from its 200-day moving average. I took that to mean that the dollar had probably peaked, which also explains this week's upticks in gold and oil along with most other commodities. I also suggested that recent stock selling had pushed some money into bonds which lowered bond yields and weakened the dollar. Which brings us back to the yen. The yen was the hardest hit of the major foreign currencies during the first four months of 2005 (as was the Japanese stock market). Part of its weakness arose from heightened tensions between that country and China. Today's apology by the Japanese prime minister for Japanese actions during World War 11 is expected to ease tensions between the two Asian giants. Given the growing dominance of the Chinese economy in that region, and the fact that China buys a lot of Japanese goods, the easing of tension is a big plus for Japan. Hence the big jump in its currency. But there's more.
Chart 1
GREENSPAN COMMENTS ON THE YUAN ... In yesterday's testimony before Congress, Mr. Greenspan expressed the view that the Chinese were getting closer to easing the peg between its currency (the yuan) and the U.S. dollar. In other words, the Chinese were moving closer to letting the yuan rise in value. That's also considered to be good for the yen. That's because the yen has been rising while the yuan hasn't. That makes Japanese exports less competitive with the Chinese. A rising yuan would make Japanese goods more competitive on world markets. While that may be good for Japan, it may not be for the U.S. Chart 2 compares the U.S. Dollar Index (green line) to the Japanese yen (orange line) for the last ten years. The yen bottomed at the start of 2002 just as the dollar was peaking. The yen has been held down by Japanese central bank buying of dollars. But it's not too far from reaching a new 10-year high. That might be another side-effect of a rising yuan. That wouldn't be good for the U.S. dollar.
Chart 2
NEGATIVE FALLOUT FROM A RISING YEN ... The U.S. has been applying a lot of pressure on the Chinese to let the yuan rise in order to ease our trade deficit and produce more manufacturing jobs in the U.S. There are some potential negative side-effects, however, if the Chinese do what we want them to do. For one thing, a rising yuan would weaken the dollar. A falling dollar boosts commodity prices and U.S. inflation. One of the factors keeping U.S. rates low has been buying by the Chinese central bank in order to keep the yuan from rising. [The Chinese buy dollars and invest them in U.S. debt]. If the Chinese stop buying dollars, they may also stop buying U.S. bonds. The result could be higher interest rates. One of the factors keeping U.S. consumer inflation relatively low has been competition from cheap Chinese imports. A strong yuan would increase import prices from China which would result in higher U.S. inflation. So the consequences from a rising yuan could be a falling dollar, higher commodity prices, higher U.S. inflation, higher U.S. interest rates, and a lower U.S. stock market.
