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The Japanese Yen: Handle With Care

This currency's baffling strength will spell disaster

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But more fundamentally, the yen now has a lot of competition as a funding currency from other low-yielders, not least of which would be the dollar. In a world in which nearly every major currency yields close to zero, the yen is no longer unique as a funding currency. So those traders that do try their luck at the carry trade have their choice of currencies to short.

Still, even with all of this as explanation, the yen’s persistent rise has been baffling, particularly when you consider that Japan’s exports are down. When you see a trend like this that is hard to explain, you might want to question its sustainability.

Financial writer John Mauldin referred to Japan as “a bug in search of a windshield” in his recent book Endgame, and I consider this an apt metaphor. Japan’s gargantuan debts and deficits have only been possible because of the country’s historically high savings rate — a rate that has been trending downward in recent years and might well turn negative soon.

When Japan has to turn to the international bond markets to fund its deficits, it’s not going to enjoy a 1% yield on its 10-year obligations. No one in their right mind would lend Japan money at 1%. No one in their right mind would lend Japan money at all!

In the rolling global debt crisis, Japan will be the next major domino to fall. When it finally has to access the international bond markets, its yields will rise to punishingly high levels. At that point, Japan will have one of two choices, both of which will almost certainly result in a hyperinflationary meltdown: default or using the printing presses to meet current obligations.

Bottom line: If you are a long-term investor, stay out of all Japanese assets. The risks simply aren’t worth it given the attractive options you can find in the United States and Europe. If you are a short-term trader, get ready. At some point in the next one to three years, Japan could prove to be the best shorting opportunity of your trading career.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Sign up for a FREE copy of his new special report: “4 Dividend Stocks to Buy and Forget.”

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