Tuesday, March 15, 2011

Japan - Ari Paul

Investors,

The devastation of the tsunami in Japan is estimated to cost $200 billion to repair, and possibly as much as $1 trillion. I haven't been able to get a clear read on the risk of nuclear disaster, but a release of radiation over a 50 mile radius is a significant risk. The Japanese government is evacuating people in a 10 mile radius and telling people in a 20 mile radius to remain indoors. Many foreign companies have been evacuating people in a 70 mile radius.

In reaction, Japanese stocks fell 16% over the last two days, Japanese treasury yields rose marginally, and the Yen strengthened by about 2%.

From an investment perspective, my first thought was that this could be the catalyst that leads Japanese treasuries and Yen to sell off. So why were treasuries steady and the Yen so strong? After a major disaster, a great deal of money needs to be repatriated to pay for repairs. For example, the Japanese Government may need to sell treasuries to raise funds for rebuilding. This means that foreign currency must be converted into Yen, which can send the Yen climbing. After the Kobe earthquake in 1995, the Yen rallied by about 15% over the next two months, before then falling 40% over the next 3 years.

Will Japanese sovereign yields rise? They really can't rise much because every 1% increase in treasury yields will require 25% of all tax revenues to cover the increased interest costs. Japan's central bank has absolutely no choice but to neutralize a yield increase with monetization.
Pundits have talked about a debt/currency crisis in Japan for a decade now and I began discussing it two years ago, but we are now truly in the end game. I believe the pressure to monetize the debt will outweigh the effect of repatriation. I am reasonably confident that the Yen will be significantly weaker vs the dollar over the next five years. I am initiating a small short Yen position in my portfolio and will short more Yen if it rallies another 5%. The Yen is likely to be extremely volatile, so any bet should be small enough that you can hold on through the turbulence.

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