Dollar’s replacement is just 6,700 miles away

Dollar’s replacement is just 6,700 miles away

Forget all this chatter about finding a new reserve currency. We already have one, and it’s called the yen.

OK, stop laughing.

Japan is in a recession, deflation is afoot and debt is approaching 200% of gross domestic product. Investors returning from two decades in hibernation and looking at Japan’s fundamentals might run away. And yet, the yen has gained 14% against the dollar over the past year.

We can deduct three things from this surreal turn of affairs. One is the absurdity of our times. Two, this whole concept of a reserve currency needs an overhaul. Three, those figuring the yen can only rise in value may be disappointed.

The first point is the most intriguing. It’s true that the yen has been a pretty consistent winner for investors betting on a weaker dollar. Regardless of its structural problems, Japan has a stability to it that’s unique. Huge shocks play out over decades or years, not months or weeks.

That said, the idea that the yen is an oasis of prosperity in an otherwise crazy world shows the extent to which things have gone mad. Is Japan, the weak link among developed economies for the last 20 years, really a place investors can escape to?

The 18 months since Bear Stearns Inc. imploded have been as disorienting as they come for investors and policymakers. Talk of another Great Depression, Lehman Brothers Holdings Inc. collapsing, bankers flying economy class, the White House being in the car business, the British pound plunging, China saving America from bankruptcy, you name it.

And now currency strategists such as Brian Kim of UBS AG in Stamford, Connecticut, say that relative to the euro, if there’s a pullback of risk-seeking you could see the yen still benefit. Kim is merely highlighting what is now conventional wisdom in currency circles. The yen is in.

The second point is more difficult to tackle. If those investors returning from hibernation looked at the US’ balance sheet, they would label it a developing economy and perhaps steer clear. With zero interest rates, astounding debt and a national savings rate that is only now perking up, the US hardly screams reserve currency.

And yet here we are, for better or worse. Rumblings in China, Russia and the Gulf states about sidelining the dollar are just that—talk. A herd mentality develops because it almost doesn’t matter what a nation’s fundamentals are once its currency is designated a reserve. It’s already a deeply ingrained and self-fulfilling belief system.

In a sense, the dollar isn’t crashing because it can’t. The fallout of such an event would reverberate through every asset class and exact a cost that the global economy can’t meet. And so, ratings companies avoid touching the US’ AAA credit grading, and the dollar proves the naysayers wrong.

Switzerland’s central bank had to fight the belief that its franc was a haven. Norwegian officials haven’t been shy about opposing the same thing. The euro, meanwhile, hardly seems ready to replace the dollar—not with so many economic weaknesses.

Hence the focus on the yen. Funding in Japan is cheap, as anyone who has engaged in the so-called yen-carry trade can attest. Borrowing in yen and putting those funds into higher-returning assets abroad sprouted an entire cottage industry.

The hardest part is getting past the idea that the world needs an anchor currency. Rather than just beginning to do the bulk of international billing in various currencies, government leaders are considering a new reserve unit. It’s worth asking, though, whether politicians will decide which currency is the reserve one. More likely, markets will decide if the reserve currency is printed in Washington or 6,700 miles (10,787km) away in Tokyo.

That gets us back to the yen. It’s hard for me to picture North Korea meeting the same demand for counterfeit 10,000-yen (Rs5,000) bills as it enjoys for $100 ones. Or a Nigerian traffic cop demanding a 2,000-yen bribe from me over a $20 (Rs962) bill. Or Colombian drug lords puzzling over a suitcase full of yen. Uhh, are we talking billions or trillions here?

There’s no political will in Tokyo to print the world’s reserve currency. Yet the real reason to be careful is the economy’s precarious outlook. The Swiss franc, for example, has long benefited from political stability. The outcome of the 30 August election in Japan doesn’t ensure that Asia’s biggest economy will get out of its multi-year funk.

No one has made much money betting against the yen recently. That’s no reason to assume Japan’s currency won’t have its share of setbacks in the next few years.


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