We worked this out when Lehman failed. In a world dominated by hugely leveraged financial institutions' portfolios, if a yen asset, say a corporate loan note financed in yen, falls substantially (20% or more) it adds to the demand for the yen as the borrower now has to borrow even more yen (or sell more of its foreign denominated assets to buy yen) to cover the loss. I am willing to wager this action would invoke a vicious cycle as the country's export base would be jeopardised further by the appreciating currency. Already jittery stock markets would unravel, initiating even more selling of dollar assets to buy more yen to make good the losses or shortfall vis-a- vis domestic institutions' yen liabilities.
It is perhaps interesting that when I visited Tokyo in March the local businessmen pronounced the notion of negative Chinese GDP growth as a near impossibility. Maybe such confidence explains their asset-liability mismatch. I really do like their use of the world impossible. I remember how it was used so often by Wall Street banking analysts to describe the plausibility of a nationwide housing slump in America; yes, impossible indeed!
As Liaquat Ahamed's excellent study of the policy follies of the 1920s reveals, moments of historical change are marked by a clustering of debilitating events and "part of the reason for the extent of the world economic collapse of 1929 to 1933 was that it was not just one crisis but a sequence of crises, ricocheting from one side of the Atlantic to the other..."3 Just look around the world at all the revealing headlines: American sub-prime losses, the Greek bond panic, Portugal and Spain's spiraling government bond yields, the IMF in Europe and prophecies of a Chinese property crash. Such headlines recall the journalist Christopher Morley's observation that, " sometimes there is so much writing on the wall the wall falls down." You will not find us short the yen anytime soon!
