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How Long Will Japan Support the Dollar?

By: Steve Johnson

12/30/2008 - 22 Comments

Back in November, Japan said they would need to support the dollar – at least in the near term.

If they don’t continue to support the dollar by buying more and more US treasury bonds, the dollar could drop by 40-50 percent against the yen.  A drop in the dollar would decrease the value of Japan’s nearly $1 trillion in dollar Reserve.  But more important then the lost in reserves, is if the dollar sinks against the Yen then the prices of Japan product will drastically increase and US consumers will no longer be able to buy Japan products. Japan exports and economy would sink with the dollar. 

For the last decade, Japan (and many other nations) have been unwilling to let this happen.  The US is still the largest economy in the world and Japan simply cannot afford to loose their biggest customer – that is unless they have already lost them.

Now that the US is clearly headed into a deep recession and the US has virtually stopped buying products from Japan, as seen by Japan’s 27% plunge in exports, there is little reason for Japan to continue to support the dollar.

On top of that, it’s going to take more and more money to continue to support the dollar as the US budget deficit is expected to grow to $1 trillion in 2009 and the Obama administration is planning to stimulate the economy with another trillion. Bailing out the US economy from this recession will take the support of the entire world.  It will take the combined effort of all wealthy nations acting together to support the dollar through this recession.  This unilateral support for the dollar, in the mist of a global financial meltdown, is unlikely to hold up and eventually the dollar will sink.

The yen has appreciated already 23 percent versus the dollar this year, the most since 1987, as the credit crisis prompted investors to flee riskier assets and repay loans in the Japanese currency.  The culture of Japan and all of Asia for that matter has created huge surpluses of savings.  These huge pools of personal savings are now going to be needed by these nations to help them through their recessions.  The pools of savings are no longer going to be used to give credit to US consumers.

Japanese Will Realize They Are Rich

A strong yen will spur the Japan domestic spending and reduce import prices, thereby increasing purchasing power.  The phony US economy, based on living off borrowed money is crumpling.  The party with US consumer living on credit cards and bloated mortgage’s funded by Japans’ savings is over.  When the dollar sinks against the Yen, the Japanese will one day realize they are rich because they have been living below their means, while saving their money for the past decade. They will suddenly be able to purchase all the nice things that Americans have been purchasing, because the yen will be worth so much more money on the global marketplace.

In the process of Japan supporting the dollar and depressing their own currency, the Japanese were unable to realize their purchasing power.  Their governments’ interference in the currency market has been artificially stifling their purchasing power for more then a decade.  The Japanese will soon realize that they are much richer then they live. 

This is just what the Japan government needs facing a recession, its people to get a major increase in purchasing power.  The increase in purchasing power will help them consume their own products and that will drive them out of their recession.  The rising yen will also help promote positive energy and political stability, as the people will surely give credit of their increase in purchasing power to the political leadership. 

Given these numerous advantages of Japan to stop supporting the dollar, my guess is that they have already begun redirecting their investments.  But if they move to fast, they could spook other nations to dump their dollars – which could result in a global race to sell dollars – and the last nation holding dollars would be the biggest looser.  If a race is sparked, the world would also have to pick a new Reserve Currency of the world and I don’t think the world is ready for that just yet.

The dollar could be the biggest story in 2009, as many economies still believe it’s too large to fail because the entire world is priced in dollars and a dollar collapse is akin to a global assets meltdown.  But, I think it is very possible and something to give serious consideration because the consequences could literally wipe out a lifetime of savings in a very short period of time.

The dollar is perhaps the most risky investment in 2009.  That means all assets priced in dollars are also very risky, which includes US stocks and bonds.  This is why I have rebalances by 401k into foreign markets. 

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