The international currency markets are increasingly focusing on the behavior of the euro against the yen and may become the battleground to watch for the next several years.
Currency traders have always focused on how the major currencies fluctuate against the dollar given that it is the preferred reserve currency for all governments and sovereign investment funds, but that approach is slowly changing.
Some economists and analysts pointed out in early 2008 that the financial crisis would shift the supply and demand globally to such an extent that it would impact the currency markets and vice versa.
The warning went unheeded by most, at least in the beginning, but now slowly finds more followers who have noticed that two export driven economies are very susceptible and dependent on how their respective currencies are being exchanged independent of the pure USD/euro or the USD/JPY trade.
The latter is primarily influenced by large carry trades and no longer reflects the underlying economic activities and dependencies.
The enclosed graph is based on a three-month fluctuation between the euro and the yen and shows a strengthening of the yen, or a weakening of the euro, of 15%. When looking back to July 2009 in comparison to today’s rate, the change is even more impressive and amounts to a 21% deviation from previous levels.
Both Japan and Europe are very dependent on manufacturing and export of goods and services and the fluctuation of the exchange rates between the two currencies has become a very good barometer to measure the health of their economies and the sustainability of such over time.
Europe is profiting form the current currency battle, but we do not believe that the current growth can be sustained given the reduced consumer spending and demand in both Japan and China.
Japan is suffering from both a slow demand for imported goods as well as a strong currency both of which do not bode very well for their already deflationary economic position of the last 20 years.
In order for Japan to boost its exports, Naoto Kan, the new Japanese Prime Minister, may have no choice but to let the Bank of Japan intervene directly in the currency market to restore some sort of temporary balance.
This direct intervention would be the first one of its kind since 2004 and may be frowned upon by its large trading partners and viewed as artificial manipulation of prevailing market forces.
Our dire prediction of 2008 is now on the verge of coming to fruition due to the impact of international trade and the flow of consumer goods.
The battle is not between the US and Japan, as most expected, but the import/export battle is being fought between Japan and Europe, at least for the time being and it will all depend on how both currencies continue to trade and the effects such will have on their respective GDP growth and ultimately their economic health.
Written by Nick Doms © 2010, all rights reserved.