Around 33 months back the Shinzo Abe backed BoJ initiated a rapid JPY depreciation that resulted in an absolute move of 50% weakening of its currency against the USD. The resolve that the Abe backed BoJ has displayed in the face of diminishing marginal benefits to the real Japanese economy has encouraged the Yen carry trade once again with borrowers borrowing in Yen and converting to USD and investing in various assets classes globally.
The danger is that asset prices can get swiftly unhinged in China,as amply displayed this month and investors can go bust if at the same time the carry trade also implodes with JPY reversing course and appreciating swiftly.
This is a real danger as we saw over the last two weeks and it is now expedient that adequate controls are put in pkace by the Chinese authorities in the correct direction. One such area is obviously the interest rates set by the PBoC given the fact that CPI inflation is low at 1.4%. Interest rates should be a whole lot lower to discourage carry trade behaviour given the leverage already present in the system, not to mention the crimped CPI.
We have heard ample reports emanating from China of Authorities wanting to arrest short sellers. Can they also arrest a short seller sitting in London or Singapore or New York? The fact of the matter is that the previous week has seen more of the latter variety trying to implode the Yen carry trade along with the Shanghai Composite and the Shenzhen Indices simultaneously and create massive panic which can potentially throw the World into a greater Depression than 1929.
Last week there was a close to 80% probability that these short sellers might have succeeded-just almost.
The desirable outcome is that PBoC loosens up monetary policy and discourage the build up of the carry trade thereby reducing leverage levels. The benchmark 1 yr rate at 4.85% with CPI at 1.4% leaves a lot of room for PBoC to cut and improve financial stability. This must be followed by restoring normalcy in capital markets and reverse the brute force measures gradually and improve investor sentiment and restore confidence in fair regulation.
These above measures will take us to the desired outcomes which as highlighted above reassigns the probability of positive outcome to 80% while relegating the doomsday probability to under 1%.
ageofdeflation 