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Fundamental Forex Commentary: Japan and the US

Deflation and a Yen which continues to strengthen have provoked a political crisis in Japan. Ichiro Ozawa – the man who turned the Democratic Party of Japan into a political force before being forced to relinquish his leadership over corruption charges – is now challenging Naoto Kan’s leadership.

The Better Man?

Mr. Ozawa thinks he would make a better Prime Minister. His implied argument: He would take action to deal with a Yen that has simply become too strong. He would be the first – thus far no one has actually acted. If trends continue, things can only get worse. Today Bloomberg reported on a discussion of a weekly Ichimoku chart by Mizuho Corporate Bank Ltd. that concluded that the US Dollar could fall below 70 Yen.

In the absence of significant action it seems quite likely that this is indeed the case- technical analysis is supremely good at describing what is likely to happen if the fundamentals of a market do not change. Please note that intervention that weakened the Yen would have the effect of immediately halting deflation- and that one simple thing would have a dramatic positive impact on the Japanese economy.

BOJ (In)Action

Which makes the inaction of the Bank of Japan all the more puzzling. It is not as if there is anything strange about intervention- the Swiss National Bank did very significant intervention over the last year and a half (quadrupling their reserves in the process- in contrast the Federal Reserve increased its assets by a factor of only 2 and a half). Let us keep a close watch on Japan. Things could change very fast.

And what of the US and the rest of the world’s economies. Today saw a rally on nothing more than a drop in a single week’s unemployment claims: stocks and commodities went up and currencies reacted accordingly. Friday will probably see new doom and gloom as second quarter US economic growth is revised downward. No doubt the Yen will strengthen again and commodity currencies could easily drop.

But Morgan Stanley reports that the deleveraging of the American consumer is almost a year ahead of schedule- while the Federal Reserve’s decision to delay an exit from quantitative easing makes it easier for lenders to facilitate the reworking of mortgages and commercial debt- further accelerating the process of reworking the balance sheet of the American family.

What This Means

Which means that once events alter the business climate of the US a virtuous cycle of hiring, new (though more temperate) consumer spending, increasing incomes and profits could result in a very rapid expansion of the economy- and probably a weakening of the dollar as money flows out of safe havens to pursue higher yields in traditionally higher risk areas like Australia and Canada.

But will Canada still qualify?

Has not Canada become the Switzerland of the Western Hemisphere?

We will see when the time comes. But that still leaves the main question: What events could possibly alter the business climate of the United States?

How about the upcoming midterm elections?

Bad News to Worse News

Each day brings worse news for the current majority: Congressional Quarterly now says that 80 house seats are ‘in play’- up from around 45 only a month ago – and that the Democrats could loose 6 to 7 seats in the Senate as well.

This makes the most likely makeup of a future Congress one where the opposition party controls the lower house while the majority of the current ruling party is very significantly reduced. Of equal importance – many of the new faces in Congress are likely to be people who are dedicated to a free markets and reducing the roadblocks and burdens that currently discourage economic activity.

This is the kind of event which can indeed alter the fundamentals of a market precisely because it alters the mass psychology of the business community.

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