The Yen and the Stock Market

The recent dive of the global stock market shocks everyone. Analysts proclaim that the correction is healthy, PE ratios are reasonable and markets will continue to rise. Media focus about the remarks from ex-Federal Reserve Chairman Alan Greenspan who said that it is possible that US will have a recession but that it is improbable. Typical Grenspan's talk that is virtually meaningless and leave you to deduct your own conclusions from the remarks.

One of the primary key to whether markets will crash is not none of the above but the availability of cheap Yen from Japan. In technical jargon, it is called the Yen Carry Trade where you borrow Yen at low interest rates and use it to buy shares or deposit in higher interest rates currencies. It is simple maths. Borrow Yen at 1.5% interest from the banks and put into Australian dollars at 5% and hey presto, you earn 3.5% from the difference. Yen has been borrrow for a wide range of activities to finance stock purchases, buying properties and other investments. It is cheap money that is available in billions.

Where does this cheap money comes from? The Japanese Government wants to keep exchange rates low so that the Yen will not appreciate against the US dollar and hurts exports. Japanese companies sell billions to the US and in exchange gets US dollars. There is a DEMAND for Yen to buy US dollars. This must be countered by a demand for US dollars using the Yen . To do that the Japanese Government buys US dollars and sells Yen. So the equation is balanced at least as far as exchange rates go.

But where do the Japaneses Government gets the yen to buy the US dollars? It is money created out of thin air. In 2003 to first quarter 2004, in 15 months , Japan created 35 trillion Yen which is equal to US$2,500 for very person in Japan. All major currencies have appreciated against the US dollar except the Yen. With such a huge amount of instant money, it is not surprising that the Yen has remained low versus the USD. This unprecedented money creation by the Bank of Japan could be the main reason for the strong growth of the global economy.

The global stock market will not be as sensitive to the US interest rate than to the Japanese interest rate. If Bank of Japan raises its interest rate, and if the Yen suddenly appreciates against the US dollar, it might be the pin that pricks the bubble.