Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Hello man, welcome to another episode of the podcast.
Speaker 3: I'm Tracy Alloway and I'm Joe.
Speaker 4: Joe.
Speaker 2: I think I know the answer to this question, But
Speaker 2: do you ever write to do list?
Speaker 4: No?
Speaker 2: Yeah, I figure, well, I make a half hearted attempt
Speaker 2: every day where it's like podcast recording one, podcast recording two,
Speaker 2: do the newsletter, reply to the following emails. But as
Speaker 2: of last week, I have seen the most epic to
Speaker 2: do list.
Speaker 5: Oh yes, yes, presumably, yeah, yeah, yeah, I saw the
Speaker 5: Scott Bessett to do list.
Speaker 3: It was basically like by the end, right.
Speaker 2: Right, so US Treasury Secretary Scott bessen there was a
Speaker 2: photo taken of him. Presumably he did this on purpose,
Speaker 2: one would hope. But he had a to do list
Speaker 2: and it basically just said buy Japanese yen and he
Speaker 2: put in the jp wy yeah, five to ten billion.
Speaker 4: Yeah.
Speaker 5: So it's pretty clear that he was not referring to
Speaker 5: personal purchases in some vacation.
Speaker 2: If that's the only thing on the Treasury secretaries to
Speaker 2: do list, he's not that busy, right.
Speaker 5: He's not, but he presumably is fairly busy. We know
Speaker 5: that the en had been weakening dramatically. We know that
Speaker 5: there has been a recent sharp strengthening. There's always talk
Speaker 5: of a en intervention here and there.
Speaker 3: I don't really.
Speaker 5: Understand fully why the end is so weak, why the
Speaker 5: US feels compelled that it's important to get involved in
Speaker 5: that market, et cetera. I have many questions.
Speaker 2: Yeah, so the US did intervene together with Japan in
Speaker 2: the yen to stop it from weakening. And what's really
Speaker 2: interesting about all of this. I mean, we love Big
Speaker 2: four and currency stories anyway, but what's interesting is this
Speaker 2: was kind of a new type of intervention. So the
Speaker 2: US actually sold euros, which was very interesting, and they
Speaker 2: also used a fed repo facility that I had completely
Speaker 2: forgotten about as well. So there are all these interesting
Speaker 2: questions about this particular incident, let's say, including the big one,
Speaker 2: which is will this be enough to stop the end weakening?
Speaker 2: And it's still very surreal to me. Whenever I look
Speaker 2: at a chart of the dollar exchange rate, the yen
Speaker 2: will always be one hundred and ten to the dollar
Speaker 2: for me. Yeah, yeah, because that was my allowance when
Speaker 2: I was there. I got one thousand yen every week
Speaker 2: and it was like roughly ten dollars, and so I
Speaker 2: have that stuck in my head, and whenever I look
Speaker 2: at the chart it's now at like one hundred and
Speaker 2: fifty five.
Speaker 3: It's kind of crazy.
Speaker 5: Yeah, no, it's pretty wild. I mean, for so long,
Speaker 5: for like the first half of our careers, the story
Speaker 5: was like strengthening and strengthening yen, lower and lower rates.
Speaker 5: At the long end of the Japanese yield curve. People
Speaker 5: used to talk about the widow maker trade because many
Speaker 5: people had gone to short various forms of Japanese paper
Speaker 5: on the expe expectation that it will blow up in
Speaker 5: some way. But it has a really blown up. But
Speaker 5: it's been quite a reversal on both the rates in
Speaker 5: the end. And again, the question I have, in addition
Speaker 5: to the tools is why is this an important thing
Speaker 5: now for the US to get involved and why do
Speaker 5: we feel so I have many questions.
Speaker 2: All right, So whenever we have big questions about capital
Speaker 2: flows or FX moves, we shine our Brad setzir bat
Speaker 2: signal into the sky and he magically appears on the podcast.
Speaker 2: So we do, in fact have the perfect guest. We
Speaker 2: are speaking once again with Brad Setzer, senior fellow at
Speaker 2: the Council on Foreign Relations. So Brad, thank you so
Speaker 2: much for coming back on odd blots.
Speaker 4: It's always fun.
Speaker 2: Maybe just to begin with, let me ask the obvious question.
Speaker 2: If your currency is weakening to the degree that you
Speaker 2: think in intervention is necessary, why doesn't the boj the
Speaker 2: central bank just raise rates.
Speaker 4: That is a very obvious question. For whatever reason, the
Speaker 4: Bank of Japan has been very slow to raise rates.
Speaker 4: So the short term policy rates about one percent. Inflation
Speaker 4: is clearly above that. They're different measures. Inflation has been
Speaker 4: above that for a long time. The stated reasons for
Speaker 4: the hesitation, as you know, the Bank of Japan has
Speaker 4: worked for so long to get inflation back to two.
Speaker 4: They don't want to prematurely cut off this shift in
Speaker 4: behavior to kind of they don't want to fall back
Speaker 4: into the zero rate, zero inflation economy. I think there's
Speaker 4: also probably a few technical reasons that I'm sure that
Speaker 4: you Hada wanted the yield curve to steepen, and it
Speaker 4: has a lot before short term rates went up, and
Speaker 4: you know, short term rates affect the cost of all
Speaker 4: the yend deposits, so it's they impact the liability side
Speaker 4: of the banking system. The banks have a lot of
Speaker 4: low yielding assets on their balance sheet. So does the
Speaker 4: Bank of Japan, so there may be some concern about
Speaker 4: pushing up the cost of funding on the banking side
Speaker 4: too fast. The theory of some in the market, not me,
Speaker 4: is that this is out of concern about how it
Speaker 4: impacts the government's overall funding cost and that if you
Speaker 4: pushed up short term rates that would push up the
Speaker 4: fiscal deficit interest costs too much. I think it's a
Speaker 4: little overstated, but that is certainly one of the considerations.
Speaker 5: I want to ask about why the yen has been
Speaker 5: so weak in the first place. But I actually before that,
Speaker 5: maybe we zoom out bigger, because like weakness in East
Speaker 5: Asian currencies in general has been a story of twenty
Speaker 5: twenty six. And you know, it's not obvious to me
Speaker 5: why East Asian currencies at all would be particularly weak
Speaker 5: these days, because all I ever read about in headlines
Speaker 5: is extraordinary. You know, current account surpluses, not in Japan
Speaker 5: per se specifically, would be the big one.
Speaker 3: It's not intuitive to be at.
Speaker 5: All that at a time when like the big chip
Speaker 5: makers are making money hand over fist, that they would
Speaker 5: be particularly weak currencies. Why do you give us this
Speaker 5: sort of view from the Asia Pacific view generally and
Speaker 5: then the Japan specific view on this year's currency moves.
Speaker 4: Well, look, you're right, the global trade surplus is now
Speaker 4: all in East Asia. The chip electron you know, basically
Speaker 4: San Francisco decided to spend a lot of money on
Speaker 4: kit that basically comes from you know, in the first instance, Japan, Korea,
Speaker 4: and Taiwan, but feeds into a lot of parts from Japan.
Speaker 4: It's pushing you know, it's help in China too. So
Speaker 4: you know, we have like really record trade surpluses throughout
Speaker 4: Asia East Asia except for Japan. We'll get to Japan later.
Speaker 4: And like, you know, Korea's current account surplus is going
Speaker 4: to go from one hundred billion and changed to somewhere
Speaker 4: between three and four hundred billion. Massive. You know, Taiwan's
Speaker 4: is probably gonna double, and you know it was big
Speaker 4: to begin with. So we're doubling means going from like
Speaker 4: fifteen to twenty five to thirty percent of GDP. These
Speaker 4: are insane numbers. With Taiwan, it's a bit different. The
Speaker 4: central bank doesn't want its currency to strengthen. It has
Speaker 4: engineered a weakening of the Taiwan dollar compared to last
Speaker 4: year by reversing crudential regulations basically letting the lifers unhedged
Speaker 4: their foreign assets. And then with Taiwan in particular, it's
Speaker 4: almost one company TSMC, and you can kind of lean
Speaker 4: on that company to tell it when it converts and
Speaker 4: when it doesn't. Bloomberg actually did one of the best
Speaker 4: stories I've ever seen about the Central Bank of China
Speaker 4: Taipei and how it is managing Taiwan's dollar without actually
Speaker 4: using this balance sheet. Korea is different. Korea has been strange.
Speaker 4: It's been this story where the better the news is
Speaker 4: for Korea, the more the Korean stock market goes up,
Speaker 4: the more foreign holders of Korean stocks have to sell
Speaker 4: because they're hitting concentration limits. And that has created a
Speaker 4: weird situation where good news for the equities for Korea's equity,
Speaker 4: so you know, Heinez and Samsung was leading to an
Speaker 4: outward flow and producing record weakness in the Korean wand
Speaker 4: that is layered on to outflows from the pension system.
Speaker 4: That is layered on to this whole story about you know,
Speaker 4: Korean day traders who used to do buy levered US
Speaker 4: ETF single stock ETFs and then Korea let them by
Speaker 4: levered single stock Korean ETFs, and that didn't turn out
Speaker 4: to be a great idea, but you know, it's sort
Speaker 4: of we end up with a world where you have
Speaker 4: this enormous positive terms of trade shock enormous that is
Speaker 4: producing record weakness, and that's in the it's in that
Speaker 4: context where we can think about the end as being
Speaker 4: another of these countries currencies that is, you know, kind
Speaker 4: of fundamentally okay. Japan has a current account surplus of
Speaker 4: five percent of GDP its investment income. It's not a
Speaker 4: trade its trade accounts would be improving butt for oil
Speaker 4: thanks to the AI stuff. It's got one of the
Speaker 4: biggest foreign asset portfolios in the world. The government of
Speaker 4: Japan has you know, still probably close to one point
Speaker 4: two trillion in reserves, that's a big number. It has
Speaker 4: nine hundred billion plus in the government pension fund foreign assets.
Speaker 4: That's a big number. GDP is now down to four trillion,
Speaker 4: so you know, the government is sitting on a foreign
Speaker 4: asset position of close to fifty percent of its GDP.
Speaker 4: The weakness was it has been throughout Asia a bit counterintuitive,
Speaker 4: but for slightly different reasons. And with Japan, you obviously
Speaker 4: have the very low ring story as a central part.
Speaker 2: So when I hear the words currency intervention, I often
Speaker 2: associate that with currency speculation, right, and here central banks
Speaker 2: will come out and say, like, oh stern words to
Speaker 2: the speculators, you better watch out, and that sort of thing.
Speaker 2: With Japan, do we have indication of how much of
Speaker 2: this is actually speculation versus to your point earlier, like
Speaker 2: actual outward investment.
Speaker 4: There's a bit of speculation around the end. You know,
Speaker 4: there's not a clean measure of the speculative flow. But
Speaker 4: like you know, look, the end was one of the
Speaker 4: lowest yielding currencies, so it was a typical funding currency.
Speaker 4: I don't think the carry trade was on an enormous scale,
Speaker 4: but there were certainly hedge funds others who more or
Speaker 4: less thought that the Ministry of Finance was going to
Speaker 4: allow the yen to weaken beyond what it had weakened before.
Speaker 4: And since you know, the end shortening the en is
Speaker 4: positive carry. There's a higher yield on dollars than on yen.
Speaker 4: As long as it's stable, you make a little bit
Speaker 4: of money, and if the end appreciates, you make a
Speaker 4: lot more money. So there was a bit of speculative
Speaker 4: betting on it, not a ton, I would say. And
Speaker 4: then you have weird hedging dynamics. So there's a little
Speaker 4: bit of a head dynamic where when the NICK goes up,
Speaker 4: foreigners holding the NICK need a hedge a bit more
Speaker 4: because some do partially hedge. When the Nasdaq goes up,
Speaker 4: the GPIF doesn't hedge, so it doesn't generate an offsetting
Speaker 4: hedging flow. And then, despite all the hedge America stories
Speaker 4: from last year, in Japan, the key fixed income hedged
Speaker 4: investors seem to have gone a little bit less hedge.
Speaker 4: The lifer hedge issue has come down, so you don't
Speaker 4: so a lot of it is not quite your classic
Speaker 4: speculative flows, although there's a bit of that. A lot
Speaker 4: of this is hedging flows amongst real money investors, so
Speaker 4: that does add a little bit of a different dynamic.
Speaker 4: But I don't discount the fact that a bunch of investors,
Speaker 4: including a bunch of hedge funds, were basically making a
Speaker 4: bet that the end would go to one seventy because
Speaker 4: Yueita was behind the curve.
Speaker 5: So let's talk about it from the US perspective. What
Speaker 5: is the reason that the weakening of the end is
Speaker 5: something that would or should concern the Treasury Department.
Speaker 4: Well, I think the classic concern, which hasn't been the
Speaker 4: concern that Secretary Vestin has articulated, is that extreme weakness
Speaker 4: in East Asian currencies gives East Asia a trade edge
Speaker 4: over American producers. I mean, classically, a week end is
Speaker 4: bad for Detroit, A weak Korean land is bad for Detroit. Right,
Speaker 4: it's really you know, the traded goods pressure, most classically
Speaker 4: through the automotive sector, that has been the traditional driver
Speaker 4: of this. And to be clear, we are like fifty,
Speaker 4: you know, the ones come back a bit, but fifteen
Speaker 4: hundreds a crisis level of the wand and Korea is
Speaker 4: not in a crisis. One sixty is an insanely weekend
Speaker 4: on any big MAC index. It pushes the end below
Speaker 4: and inflation adjusted terms where it was in the nineteen seventies.
Speaker 4: We're back to the nineteen sixties. These are extreme undervaluations
Speaker 4: in my view. And so in that sense, the classic
Speaker 4: concern would be that this gives all these guys a
Speaker 4: huge edge over American manufacturers. That hasn't been what Bestin
Speaker 4: has emphasized. He's emphasized well, the weekend is putting pressure
Speaker 4: on the wand is adding to the generalized malaise bizarreness
Speaker 4: where good news is bad news for a lot of
Speaker 4: Asian currencies. And then and there's a sense that this
Speaker 4: could create pressure on the treasury market. Now, to be clear,
Speaker 4: if the yen just falls, that makes the value of
Speaker 4: Japanese investments in treasuries higher. So the impact on the
Speaker 4: treasury market would come if the Japanese resisted that use
Speaker 4: their reserves, and the excessive use of their reserves or
Speaker 4: the use of their reserves started to put pressure on
Speaker 4: the treasury market because they have to fund they would
Speaker 4: fund it by selling treasuries. So I think part of
Speaker 4: Besson's theory of the case is that by joining with
Speaker 4: the Japanese, first of all, you know, we're supporting the
Speaker 4: end from an incredibly weak level. It's arguably overshot. It
Speaker 4: has decoupled from five year ten year rate differentials for
Speaker 4: the past several months, past year even And by helping
Speaker 4: the Japanese, we're helping a friend, that's what the President says,
Speaker 4: and we can jointly intervene in a way that we're
Speaker 4: reduces the possible pressure on the treasury market. That would
Speaker 4: be I think the explanation I would give, but I
Speaker 4: you know Besson has n't been He's more I mean
Speaker 4: the President said it was to help a friend. Bessant
Speaker 4: has said is to avoid destabilization throughout the Asia currency complex.
Speaker 2: Why did they do it in euros or why did
Speaker 2: the US do it in euros? They sold euros?
Speaker 4: I mean, you know, some of it is just Secretary
Speaker 4: Besson being a former currency trader wanting to have presumably
Speaker 4: a bit of fun. You know, we have euros, we
Speaker 4: can't use euros. We have a few more dollars, but
Speaker 4: only a few more dollars. I mean, you can debate.
Speaker 4: I mean, this was clearly an intervention, but you know,
Speaker 4: when you shift your the composition of your reserves around,
Speaker 4: sometimes that's not even viewed as intervention because you're not
Speaker 4: selling your currency to buy another guy's currency. I think
Speaker 4: he presumably did it because he wanted to be a
Speaker 4: bit cute and say, well, this isn't an This is
Speaker 4: not a view about the dollar that we still want
Speaker 4: a strong dollar. This is just a view about the yen.
Speaker 4: And we're just expressing this in a way that makes
Speaker 4: it clear that this is a view about the en.
Speaker 4: It also let him do like kind of surprising things,
Speaker 4: like there was the rate check in euro yen, which
Speaker 4: caused a lot of confusion in the market. But at
Speaker 4: the end of the day, the you know, we don't
Speaker 4: know the volume, we don't know if he actually did
Speaker 4: the five to ten. Maybe we'll see in a week
Speaker 4: or so. But the vast bulk of the intervention was
Speaker 4: from the Japan's Ministry of Finance, and it was in
Speaker 4: dollar yen, So fundamentally this was a dollar yen intervention,
Speaker 4: not a euro yen intervention.
Speaker 5: Brad, you mentioned that if you were to go buy
Speaker 5: something like the Big Mac Index, the dollar yen or
Speaker 5: the en is at historically weak levels. And of course
Speaker 5: there's all kinds of attempts to measure like what like
Speaker 5: fair value of a currency is, right, so you mentioned
Speaker 5: the Big Mac Index, and then there's like, I don't know,
Speaker 5: beer models and rear models and exchange rate differential models
Speaker 5: and GDP differential models. Do any of them work anymore?
Speaker 5: Are any of them consistently either predictive or useful? Or like,
Speaker 5: what is the state of all of these sort of
Speaker 5: classical approaches to determining fairvlie of any given currency.
Speaker 4: The Big MAC index is a version of purchasing parity
Speaker 4: that sort of prices, broadly speaking, should be the same
Speaker 4: if you're comparable levels of development. Recently, particularly visa the Asia,
Speaker 4: the market pressure, the financial pressures have pulled currencies further
Speaker 4: away from their purchasing power parity levels. So that hasn't
Speaker 4: as a predictive variable. That hasn't worked as an analytical tool.
Speaker 4: I feel think it's valuable. A behavioral equilibrium exchange rate
Speaker 4: model fundamentally looks at policy settings today and says, we
Speaker 4: know what's the impact of the policy settings, and then
Speaker 4: it says, we don't know the equilibrium value of the
Speaker 4: currency is, but we know what it is where it
Speaker 4: has been in the past. So given the policies and
Speaker 4: given the past, is the currency strong or weak? All
Speaker 4: the Asian currencies kind of score is weak on this
Speaker 4: because they are fundamentally incredibly weak. I mean, we haven't
Speaker 4: talked about China, but China has a big and growing
Speaker 4: trades are Plus, use a current account based model, you'll
Speaker 4: find that China's currency is undervalued. Certainly Korea's currency is
Speaker 4: undervalued on a current account based model. All these show
Speaker 4: is undervalued on behaviorable exchange rate based models. So basically,
Speaker 4: like what we know is that financial flows have pulled
Speaker 4: currencies quite far away from any of the more fundamental
Speaker 4: or purchasing power based measures.
Speaker 2: So I want to go back to the idea of
Speaker 2: avoiding additional pressure on the US treasury market. And a
Speaker 2: big component of this seems to be use of this
Speaker 2: FED facility that I mentioned earlier. It's called the Foreign
Speaker 2: and International Monetary Authorities REPO Facility very catchy or FEMA,
Speaker 2: and it basically allows foreign central banks to use their
Speaker 2: treasuries as collateral to get dollars. But from what I understand,
Speaker 2: and I should say, this facility I think came about
Speaker 2: during twenty twenty during the pandemic with the big treasury
Speaker 2: market route. From what I understand, it charges above market
Speaker 2: rates for central banks. And so one of the criticisms
Speaker 2: I've seen lately, or maybe concerns, is that the FEMA
Speaker 2: REPO facility is ultimately going to be uneconomical for central banks,
Speaker 2: like why would they want to use it if they
Speaker 2: could just repo treasuries at cheaper market rates. And then secondly,
Speaker 2: the facility is also capped at something like sixty billions,
Speaker 2: So if you need to intervene again, someone's going to
Speaker 2: have to raise that limit. What are the sort of
Speaker 2: pros and cons of using this particular facility in this way.
Speaker 3: You're a fan, right, I'm a fan.
Speaker 4: I publicly, I privately pushed for it back when I
Speaker 4: was at the Treasury. I publicly pushed for it in
Speaker 4: twenty twenty. I think it is a useful tool. The
Speaker 4: basic idea is that central banks have a lot of
Speaker 4: really good collateral and if they need cash, they don't
Speaker 4: actually have to go and sell the treasuries into the
Speaker 4: cash bond market. They can just repo them at the FED,
Speaker 4: get dollars and then intervene that way, and it's zero
Speaker 4: risk to the FED, and the FED can always offset
Speaker 4: any monetary impact with its domestic operations, so there's no
Speaker 4: necessary monetary impact. It's just a way to allow in
Speaker 4: times of stress or times of pressure, a central bank
Speaker 4: to avoid having to immediately sell treasuries. And remember the
Speaker 4: in twenty twenty we kind of got into a downward
Speaker 4: spiral in the treasury market where central bank sales were
Speaker 4: sort of begetting begatting private sales, and the long bonds
Speaker 4: was really selling off and the FED had to come
Speaker 4: in and do a lot of direct bond purchases. So
Speaker 4: you know, it sort of makes sense to have this
Speaker 4: additional tool in the tool kit. You know, why do
Speaker 4: it with the FED rather than with a Well, first
Speaker 4: of all, I guess you know the FED, you know,
Speaker 4: not in this case is a little quieter as a counterparty.
Speaker 4: I mean, it is disclosed, but with a weak lag
Speaker 4: it is in theory. You know, if you get rid
Speaker 4: of the cap, it's unlimited in the quantities, and then
Speaker 4: the premium is there. It's not huge, but you know,
Speaker 4: you can debate where it is not. It was not
Speaker 4: meant to be used as a as a substitute for
Speaker 4: REPO in ordinary conditions, so it does have a premium.
Speaker 4: I think you can argue that right now, if you're
Speaker 4: the Ministry of Finance and you got a legacy five
Speaker 4: year bond with a pretty high coupond, you're better off
Speaker 4: using FEMA REPO than dumping it in the market. You're
Speaker 4: gonna be able to cover the cost of FEMA out
Speaker 4: of the cuban on the bond. And if obviously, if
Speaker 4: you sell the bond, you're never gonna get that bond
Speaker 4: and that heel back. It gives the you know, the
Speaker 4: Ministry of Finance a bit of flexibility at a minimum.
Speaker 4: It means it can intervene and then sell treasuries with
Speaker 4: a lag. It doesn't have to sort of immediately sell. Now,
Speaker 4: Japan does have a cash buffer. When they've intervened in
Speaker 4: the past, for whatever reason, they haven't used their cash buffer.
Speaker 4: They've pretty directly sold treasuries. So I think, you know,
Speaker 4: it just gives another tool to the Ministry of Finance
Speaker 4: and gives the Ministry of Finance more options about how
Speaker 4: it generates the dollars that it's self.
Speaker 5: Is there anything stuff upping Secretary Bessent from saying, you
Speaker 5: know what.
Speaker 3: One hundred and fifty dollars, one hundred and fifty end.
Speaker 5: Of the dollar. That is our line in the sand.
Speaker 5: We're not gonna let it weaken beyond that. And then
Speaker 5: you might not even have to spend a penny because
Speaker 5: you know, no one's gonna people might not want to
Speaker 5: test it, and you just say, we have unlimited, unlimited
Speaker 5: firepower because we're spending our own currency.
Speaker 3: We're just gonna cap it there.
Speaker 4: Yeah, there's something that limits Secretary Bestent from doing that,
Speaker 4: which is that he doesn't control the fed's balance sheet. Okay,
Speaker 4: Secretary Bessent just has the ESF. Right now, the ESF
Speaker 4: has ballpark twenty billion in FX ballpark twenty billion in
Speaker 4: like liquid dollar cash, and then the special drawing rights,
Speaker 4: which it has like one hundred and sixty hundred and
Speaker 4: seventy billion of a lot but not unlimited. And using
Speaker 4: the special drawing rights is kind of even more out
Speaker 4: there than using FEMA repo. You know, it's sort of
Speaker 4: so you know, the Treasury on its own probably doesn't
Speaker 4: have the firepower. Now you can argue that between the
Speaker 4: Treasury the MOTH, if Japan could through some magic change
Speaker 4: some of the pension funds operating guidance so that it
Speaker 4: started hedging its nine hundred and fifty billion dollar portfolio,
Speaker 4: there's more than enough firepower there collectively to set a target,
Speaker 4: sort of a yield curve control type target one p
Speaker 4: fifty probably be more like one sixty now, and thereby
Speaker 4: implement that so you know, whatever it takes, this is
Speaker 4: going to stay below one fifty or one sixty. The
Speaker 4: world does change. Oil shocks happen, inflation shocks, the FED
Speaker 4: maybe raising rates. People think the bank of demands is
Speaker 4: likely now to raise rates. So I think the risk
Speaker 4: on that is that you get locked into defending a
Speaker 4: level and then the world changes. But you know, conceptually
Speaker 4: you could try to do that. I think what the
Speaker 4: Ministry of Finance is trying to do is re establish
Speaker 4: fear in the market round one sixty. I mean that
Speaker 4: used to be kind of a level where you know,
Speaker 4: if you were going to go short the en, you'd
Speaker 4: be a little nervous that the moth might come in
Speaker 4: and whack you. But then when they.
Speaker 3: Didn't defend whacking, right, let me.
Speaker 4: Look, the weak side of the yen has been defined
Speaker 4: by the Ministry of Finance for the past several years.
Speaker 4: I mean, that's that's a conventional view in the market,
Speaker 4: given that the interest rate differential favors the dollar. By
Speaker 4: the way, we should discuss fiscal policy because US fiscal
Speaker 4: policy is way worse than Japanese fiscal policy. So I
Speaker 4: don't buy this is fiscal fears or whatever it is
Speaker 4: rate differentials, but the rate differential has favored the dollar
Speaker 4: and the limit for the past I would say three
Speaker 4: years on how weak the yen gets has been set
Speaker 4: by the mof and when the moth didn't intervene at
Speaker 4: one sixty, and then the last time an interviewed at
Speaker 4: one sixty two, you know, people thought, well, maybe they're
Speaker 4: going to allow further moves, and we'll make a bet
Speaker 4: that the moth is going to tolerate a week or yen,
Speaker 4: given that UAITE has been slow to raise rates. And
Speaker 4: so I think this is fundamentally about saying we're going
Speaker 4: to defend one sixty. There's a lot of risk around
Speaker 4: one sixty. Be careful if you want to just go
Speaker 4: short yen when you're close to that level, which is
Speaker 4: a softer version of the we're just going to defend
Speaker 4: one fifty to kingdom. Come all right?
Speaker 2: Well, on that note, perhaps the biggest question other than
Speaker 2: you know, why did all of this happen? Is is
Speaker 2: it going to work? And I mentioned earlier the yen
Speaker 2: is trading at like one fifty five six to the dollar.
Speaker 2: That's better than where it was before this intervention, but
Speaker 2: it is starting to weaken ever so slightly again. And
Speaker 2: on that note, Adam Posen had pretty funny quote in
Speaker 2: the Financial Times. Did you say yet so basically saying,
Speaker 2: verbatim quote the irony of the guy working for Sore
Speaker 2: and Stanley drucken Miller who broke the Bank of England
Speaker 2: back in ninety two. Pretending that you can do FX
Speaker 2: intervention alone and lastingly defend a currency is just amazing.
Speaker 2: So again this idea of like how much firepower does
Speaker 2: the US actually have? Does this need to be more coordinated?
Speaker 2: Do you think this is enough?
Speaker 4: I think it will be enough if the Bank of
Speaker 4: Japan is going to raise rates and maybe raise rates
Speaker 4: several times. I think the only reason why it wouldn't
Speaker 4: be enough if the Bank of Japan is going to
Speaker 4: raise rates. And look, I think if the Bank of
Speaker 4: Japan doesn't raise rates in September, this will be tested clearly.
Speaker 4: I mean, that would signal there's not full commitment inside
Speaker 4: Japan to defending the currency. And even in the classic sense,
Speaker 4: the monetary and fiscal authorities have different views. But if
Speaker 4: the Bank of Japan does raise raids, the other side
Speaker 4: of the currency pair is the dollar, and so it
Speaker 4: depends a little bit on what does. But if the
Speaker 4: Bank of Japan is raising rates faster than the FED
Speaker 4: from this point on, I actually do think this will work.
Speaker 4: You know, there's Adam never believes currency intervention works by
Speaker 4: the way, So it's not at all a surprise that
Speaker 4: he has this view, and I think he should reflect
Speaker 4: a little bit on why the yen and why currency
Speaker 4: traders are nervous around key levels, because in the short run,
Speaker 4: most market people I talked to say intervention can work
Speaker 4: in a over a reasonably short period of time, and
Speaker 4: it can work over a longer period of time. If
Speaker 4: the currency is overshot. I would say the yen has
Speaker 4: overshot if the fundamentals are evolving in a way that
Speaker 4: is going to be eventually favorable to that currency. You
Speaker 4: can make that argument with Japan. You know, oil prices,
Speaker 4: if you know, that depends on what happens in the
Speaker 4: Strait and with Iran, but oil prices are not at
Speaker 4: their highs. That helps Japan. The BOJ seems likely to
Speaker 4: raise rates in September. Certainly, the BOJ could be on
Speaker 4: a path that brings short term rates up too closer
Speaker 4: to you know, inflation, so on a path that leads
Speaker 4: it to two over time, that should support the end
Speaker 4: if the FED stable. Long term Japanese rates have converged
Speaker 4: with long term US rates, so the long run interest
Speaker 4: rate differential is now actually at odds with the en.
Speaker 4: It's given this rate differential, the end should be stronger.
Speaker 4: The current account is actually quite solid five percent of GDP.
Speaker 4: Japan's getting ever more money on the same level of
Speaker 4: its US portfolio because US rates are now higher than
Speaker 4: they were when Japan bought his original bond, So that's
Speaker 4: not really at risk. And you know, the key thing
Speaker 4: is that you got to change expectations, and the expectations
Speaker 4: have been that the EN's going to stay weak and
Speaker 4: maybe get weaker. So in that context, this huge foreign
Speaker 4: portfolio of Japanese institutional investors is generally becoming less hedged
Speaker 4: over time. You change that, and I think you change
Speaker 4: the dynamics. And where I probably differ a bit from
Speaker 4: people like Adam or more like the conventional international macroeconomics school,
Speaker 4: is that, you know, I do think Japan is unique
Speaker 4: in a couple of ways. One way it has been
Speaker 4: unique is that, you know, the companies that have this
Speaker 4: massive foreign presence make enormous profits abroad. Those profits translate
Speaker 4: into enormous gen profits, but they don't actually bring the
Speaker 4: dollars euros you on that they earn a broad back home.
Speaker 4: They tend to reinvest, so that doesn't generate a flow,
Speaker 4: and then the irony is a lot of the non
Speaker 4: FDI foreign assets are held by the government. You know,
Speaker 4: the bulk of the unheaded, unheedged portfolio is actually in
Speaker 4: the hands of them off and the GPIF, the pension fund,
Speaker 4: and they typically don't repatriate, so you know, they're generating.
Speaker 4: You know, the reserves were generating thirty five to forty
Speaker 4: billion an interest a year, but in normal times that
Speaker 4: just was compounding Abroad, the GPIF gets dividends, it gets interest,
Speaker 4: it doesn't repatriate that. Now there's some portfolio rebalancing. There's
Speaker 4: some additional complexities. I won't go into that, but in
Speaker 4: the normal course of action, all this interest income that
Speaker 4: goes to the government, which is well above you know,
Speaker 4: it's well above a percentage point of GDP, it's heading
Speaker 4: towards two percentage points of GDP, doesn't hit the FX market.
Speaker 4: So in a sense, I think in order to equilibriate flows,
Speaker 4: you're gonna need to see a way to you know,
Speaker 4: have the winner of a weekend, which in a financial
Speaker 4: sense has been the government of Japan takes some of
Speaker 4: its winnings and bring them back home. And so in
Speaker 4: that sense, I tend to view this a little more favorably.
Speaker 4: I think this is part of these conditions needed to
Speaker 4: set a floor under the end over time, together with
Speaker 4: the Bank of Japan. So to me, you got to
Speaker 4: have the Bank of Japan and then you have to
Speaker 4: have the flow dynamics. And the interesting thing about Japan
Speaker 4: is that the government is by far the biggest actor
Speaker 4: on the flow dynamics. It has the biggest foreign asset position,
Speaker 4: and it has the biggest capital gains from yen weakness.
Speaker 5: By the way, for those who don't know the numbers,
Speaker 5: you know, as you mentioned, the long end of the
Speaker 5: curves in the US and Japan converge somewhat, but you know,
Speaker 5: the FEDS current rates there's between three and a half
Speaker 5: and three and a quarter. Bank of Japan is till
Speaker 5: one percent. So that's really where this gap persists. We'll see,
Speaker 5: as you mentioned, if the BOJ closed it. Before we wrap,
Speaker 5: let's talk about fiscal policy for a moment, because you know,
Speaker 5: going back at twenty sixteen, the yield on the Japanese
Speaker 5: thirty year was like zero point h five, like something
Speaker 5: like truly nothing, and now it's like around four percent.
Speaker 5: There are these because the debt to GDP is so
Speaker 5: high there are these fears that if rates rise across
Speaker 5: the curve, a significant share of government expenditures are in
Speaker 5: the form of payments. That further is the information problem
Speaker 5: than you have what people call fyscal dominance. It spirals
Speaker 5: out of control. The central bank can't fix it. That
Speaker 5: is sort of like the classical version of why some
Speaker 5: people think that you should short the end because it
Speaker 5: will one day be worth confetti or something like that.
Speaker 4: What is wrong with.
Speaker 5: The theory that this is the piper being paid? Is
Speaker 5: that a phrase, the piper being paid for years of
Speaker 5: overly loose fiscal policy.
Speaker 4: Well, I like the way you phrased it as years
Speaker 4: of overly lose fiscal policy, because you didn't say today's
Speaker 4: fiscal policy is overly loose. What has changed, certainly compared
Speaker 4: to twenty fourteen, even compared to twenty sixteen, is that
Speaker 4: the primary balance, so excluding interests, government revenues relative to expenditures,
Speaker 4: is now in balance. It's now flat. There's no primary deficit.
Speaker 4: That makes Japan one of the better G seven economy,
Speaker 4: certainly better in the United States, certainly better than the UK,
Speaker 4: certainly better than France. I think better than Germany now too.
Speaker 4: I mean, I think if you count the defense spending,
Speaker 4: so Japan no longer has a big primary deficit. It's
Speaker 4: primary is actually trending towards a primary surplus. The moth
Speaker 4: loves to play games where if you don't do a stimulus,
Speaker 4: you actually tighten, because the way they structure the budget,
Speaker 4: they sort of force the government to go out and
Speaker 4: argue for a stimulus to offset what they mechanically have
Speaker 4: baked in as a tightening, which is why we've ended up.
Speaker 4: You know, Japan has outperformed the IMF's forecast this year.
Speaker 4: It's really you know, at a primary balance rather than
Speaker 4: in a modest one percent primary deficit, and so you know,
Speaker 4: you're not in a position where things are on the
Speaker 4: edge of spiraling out of control. Now. It is certainly
Speaker 4: true that the interest burden will go up if the
Speaker 4: Bank of Japan hikes rates, and it will actually go
Speaker 4: up even if the Bank of Deman doesn't hike rates,
Speaker 4: because there's an awful lot of bonds that were issued
Speaker 4: at the past at very very low rates. They will mature,
Speaker 4: they'll have to be refinanced with higher inflation, higher nominal growth.
Speaker 4: The debt dynamics don't go crazy because you have higher
Speaker 4: nominal rates, but your nominal rates aren't wildly out of
Speaker 4: line with nominal growth. Real rates are probably still below
Speaker 4: or equal to real growth, and your primary is in
Speaker 4: an okay position. The other weird thing about Japan is
Speaker 4: that the government of Japan holds on its balance sheet.
Speaker 4: So the Ministry of Finance is part of the government.
Speaker 4: It holds the reserves. The reserves in Japan make money.
Speaker 4: They are in dollars with this higher interest rate compared
Speaker 4: to the short term cost of funding and yen. The
Speaker 4: gpis the government pension fund makes money. It has higher
Speaker 4: yielding foreign assets. So the net interest payments on Japan
Speaker 4: are actually for at times they've been close to zero.
Speaker 4: Now that's a function in part of the backward looking
Speaker 4: low rates, but it's also a function of the fact
Speaker 4: that Japan's government has this massive foreign asset position. Long
Speaker 4: winded way of saying there is you should worry if
Speaker 4: nominal rates go way up and inflation doesn't go up.
Speaker 4: But if nominal rates converge to levels that are consistent
Speaker 4: with inflation, and if the primary stays where it is,
Speaker 4: Japan's debt dynamics are actually not bad. The net debt
Speaker 4: levels have been falling in five years without much change,
Speaker 4: net debt in the US will surpass or be close
Speaker 4: to that of Japan. And remember when you're shortened the
Speaker 4: end and to go long the dollar, you're going long
Speaker 4: US fiscal And I would argue, if you look at
Speaker 4: the full range of variables, not gross debt, but the
Speaker 4: dynamic path of net debt, the primary absolutely the fiscal
Speaker 4: balance one percent of GDP in last year, and that's
Speaker 4: not the US. We're at six. We were five ish
Speaker 4: last year, but we're now at six. We're heading up.
Speaker 4: That's before the defense spending. I think what has gotten
Speaker 4: people nervous is Takeichi doesn't want, at a minimum, to
Speaker 4: get a bigger surplus. She's pushing back against the moths plans.
Speaker 4: She may want to go back to a modest primary,
Speaker 4: and she expresses this in a way that generates a
Speaker 4: lot of anks. But the underlining fiscal performance of Japan.
Speaker 4: Stack up Japan using the IMF fiscal monitor variables against
Speaker 4: the US, and then compare that to the rhetoric that
Speaker 4: is tossed around, and I would say there's a very
Speaker 4: big gap.
Speaker 2: All right, Well, On that note, Brad, thank you so
Speaker 2: much for coming back on the show. Really appreciate it.
Speaker 4: Oh thanks, thanks for letting me explain my this is
Speaker 4: one area where I'm not the most conventional. And just
Speaker 4: remember this last thing. Just always remember Japan is selling
Speaker 4: dollars at by between eighty and one hundred depending on
Speaker 4: when they bought it, and somewhere around one sixty. This
Speaker 4: and the worst you can say this operation. It reduces
Speaker 4: gross debt in a really big way.
Speaker 3: That was excellent.
Speaker 2: Thanks Brad.
Speaker 3: Hopefully talk to you soon, but not too soon, Joe.
Speaker 2: Always good to catch up with Brad and get his perspective.
Speaker 3: Yeah, a few things.
Speaker 2: Stood out from that conversation. So one, it is kind
Speaker 2: of crazy how long the memory of the lost decade
Speaker 2: is lingering here. And we see this time and time again,
Speaker 2: both in economics and the business world, which is like
Speaker 2: people just remember the past cycle, right, and it influences
Speaker 2: their current behavior understandably so in the case of Japan.
Speaker 2: The other thing that stood out to me is this
Speaker 2: idea of Okay, the treasury has done this sort of
Speaker 2: creative intervention in order to ease pressure on long term treasuries,
Speaker 2: but there seems to be a tension there with what
Speaker 2: the Fed's doing ye at the moment, right, So Warsh
Speaker 2: is like, ah, you know, like markets, you you have
Speaker 2: more of an activist, say, and where treasury yields are going,
Speaker 2: it shouldn't all be about the central bank. And so
Speaker 2: we've seen longer term treasure yields go up. So now
Speaker 2: you have this weird situation where like Treasury clearly wants
Speaker 2: them to come down, whereas the FED is kind of
Speaker 2: like do your own thing.
Speaker 3: Totally, there's lots of in there.
Speaker 5: One of the first things that Brad said that I
Speaker 5: thought was interesting and it sort of and it speaks
Speaker 5: to your point about the last decade is he's like, oh,
Speaker 5: the bojsn all this work to get inflation back to
Speaker 5: two percent. And in my mind I was thinking, like, oh, yeah, right,
Speaker 5: like they must when he says all this work, they're
Speaker 5: trying to get inflation back down. But then I remember
Speaker 5: that in other direction, and so like you know, for
Speaker 5: years the story is like no inflation, No, maybe they
Speaker 5: just want to let it run hot a little while.
Speaker 5: To fully put the lost really multiple decades of like
Speaker 5: no inflation truly in the past. I also think it
Speaker 5: is interesting and probably no one really talks about it,
Speaker 5: the idea that Japan's fiscal position, at least by a
Speaker 5: certain objective measures, clearly improving, clearly looking better than the
Speaker 5: trajectory of the US these days, at least if you're
Speaker 5: looking at a primary deficit. And then to his point,
Speaker 5: you know, there's numerous you know, the classical metrics that
Speaker 5: economists use to measure the valuation of a currency. We
Speaker 5: know none of them are that great as metrics go,
Speaker 5: but they all point it to the end in fact
Speaker 5: being undervalued.
Speaker 2: Yeah, all right, I think we should end it there
Speaker 2: before I make a terrible turning Japanese.
Speaker 5: Oh you know what I thought it would pun but
Speaker 5: someone had already used it was keep calm and carry in.
Speaker 3: But uh yeah, right, Oh.
Speaker 5: You know it's like I'm saying it act usually been
Speaker 5: used a handful of times. Uh yeah, I just looked
Speaker 5: it up. It's just a few random you need to.
Speaker 2: Make those posters. I see them on the wall.
Speaker 1: Yeah.
Speaker 5: If I had been the first, I would do it,
Speaker 5: but I was not.
Speaker 3: All right, shall we leave it there, Let's leave it there.
Speaker 2: This has been another episode of the aud Thoughts podcast.
Speaker 2: I'm Tracy Alloway. You can follow me at Tracy Alloway
Speaker 2: and I'm Joe Isn't All.
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