Axel Merk: Currencies: Crisis & Opportunity

Axel Merk, Merk Funds, published a new "Merk Insights" newsletter entitled "Currencies: Crisis & Opportunity".

In this newsletter, he discusses the choices to be made by Germany and tries to understand why Germany is so generous:

• The exposure of financial institutions towards Greek debt. A lot of progress has been made in making the European banking system more robust; the envisioned 53% write-down of Greek debt is priced into markets already. Concerns regarding outright exposure to Greece have abated. Rather, concerns linger about the inter-dependency across financial institutions, the potential “contagion” as other countries – and thus financial institutions across Europe and beyond - may be considered at increased risk of default.
• In 2010, Germany exported €5.9 billion worth of goods to Greece, a 10.2% drop versus the previous year. While significant, Germany’s $3 trillion economy could stomach losing exports to Greece.
• Germany’s desire for peace in Europe.

Merk also explains that "Relative calm has come back to the market, but at a price: for Germany, it is that it now owns the Greek problem."

 He goes on to explain that "Another price has been paid on the monetary front. Since November 1, 2011, when Mario Draghi became President of the European Central Bank (ECB), we’ve witnessed a seismic shift in how monetary policy is being conducted. While we applaud Draghi for his clarity and determination, his decision to provide almost €500 billion in three-year financing to banks (LTRO) at a mere 1% may come at a tremendous cost."

For now, the market appears ecstatic but it may lead to serious problems down the road.

After talking about the currency crisis, he discusses about the opportunities:

Massive short positions previously built-up need to be unwound. As central bankers around the world hope for the best, but plan for the worst, lots of money is being printed: by the Fed, the ECB, the Bank of England (BoE) and Bank of Japan (BoJ), to name the prime instigators. Commodity currencies, i.e. the Australian Dollar (AUD), New Zealand Dollar (NZD) and Canadian Dollar (CAD) should be the main beneficiaries. While these currencies have performed well, Australia is undergoing some domestic political turmoil and Canada’s fate is closely linked to that of the U.S.; as a result, the NZD would be our favorite in that group. Having said that, geopolitical tensions and monetary easing have boosted oil prices in particular, causing headwinds to global economic growth and, with it, also to commodity currencies. If those headwinds play out further, we would make the Norwegian Krone (NOK) our preferred choice, as Norway benefits from rising oil prices, as well as providing investors with relative safety in Europe. It’s not surprising that gold, the one currency with intrinsic value, continues to appreciate in this environment. 

Related articles

• You: Eurozone crisis live: ECB to launch massive cash injection (guardian.co.uk)
• Draghi: Greek compliance must be 'flawless' (sfgate.com)

Japanese Yen: The Next Currency Crisis ?

We now have a debt crisis in Europe, that could well turn into a currency crisis. In the meantime, the Japanese Yen (JPY) is stronger than ever, although Japan's public debt to GDP has reached an amazing 220% of GDP.

The reasons for the strength of the Japanese Yen have been  its low external debt (most debt is owned by Japanese), large reserves and current account surplus.

However, Japan had a trade deficit in 2011, the first time since 1980 (See chart below courtesy of Trading Economics). The current account was still positive, but greatly reduced compared to previous years. If the trade deficit was to continue it could weaken the Yen, making it less of a safe heaven, and increase interest rates, which could snowball into a debt crisis and quickly deteriorate in a currency crisis.

Many people see Asian currencies, as being strong currencies. However, in 2011, with India debt to GDP over 90%, the Indian Rupee declined by up to 15% against the US dollar, although it recently rallied somewhat.

What really destroys a currency is debt. Any currency with large amount of debt is at risk nowadays. There are not many fiat currencies that could qualify as safe haven now. For that reason, I don't consider the Japanese Yen and (especially) the US dollar as safe investment at least in the long term.

If you want to learn more about the Japanese Yen risk, check Mish Shedlock and Kyle Bass.

Jim Rogers: Buy the Euro and the Swiss Franc in 2012

Apparently, despite all the talks about a currency crisis in Europe, I'm not the only one to think the Euro may be a buy in 2012, as Jim Rogers was interviewed on CNBC on the 3rd of January 2012 saying he would consider investing in the European currency along with the Swiss Franc. The main reasons he wants to invest in the Euro are the large short position in the Euro and the fact that it is an election year in France, so they will probably do something (spend money or monetize the debt) to make the market feel better for a while. However, he believes this would be a terrible mistake and we'll have to pay the price in 2013-2014.
I'm also worried about the Japanese Yen, as in the last few month they had a trade deficit. If this persists, it would be negative for the Yen. I suppose Jim Rogers plans to convert some of his Japanese Yen holdings into Euro and CHF.