Mechanisms of Reconciliation in the Currency Markets & Some Thoughts on the Japanese Yen Vis-à-Vis the Euro
While perusing the history books, one cannot help but encounter repeated governmental interventions in the monetary sphere. Back in 16th century England, the fetish of the monarch who meddled with money was the nasty cocktail of a vicious debasement with a stubborn maintenance of legal tender laws. Today’s manipulations are so wide-ranging that one can scarcely list them all with any ease. However, one notable means of denying economic reality today is the monetization of paper. Any sign of trouble in supposedly ‘socially key institutions’ is deemed to give rise to a hearty: ‘No problem, the central bank can buy it!’ Is it any surprise, then, that the most ‘socially key’ (hah!) of all ‘socially key institutions’ — governments — are seen to put virtually the entirety of their paper on their respective central bank balance sheets? Be this as it may, we must always recall the glimmer of hope in monetary affairs; the dealings among free men have always revealed folly (if only momentarily). Here I discuss the ‘mechanisms of reconciliation’ in currency markets and conclude the potential for a short position in the EURJPY currency pair.
A Policy of Denying Reality: Got a Problem? No problem! Monetize it baby!
We’re aware that it’s not a new or rare thing to say the modern-day proponents of centrally planned money are pursuing a folly that might be likened to the pursuit of alchemy. In fact, some chartalists (‘modern monetary theorists‘) go as far as to wear this analogy as a badge of pride! As mentioned in a piece that we posted a few weeks ago, the intellectual legacy of the Federal Reserve is historically intertwined with the notion that public ordainment is a legitimate means of assigning value. In the words of Murray Rothbard, this is nothing more than “[a revolt] against the ontological structure of reality itself, against the “very organization of nature”; against the universe as such.“ To quote the telling phrase from one of Roosevelt’s speeches to Congress during the enactment of the Gold Reserve Act of 1934:
In pure theory, of course, a government could issue mere tokens to serve as money— tokens which would be accepted at their face value if it were certain that the amount of these tokens were permanently limited and confined to the total amount necessary for the daily cash needs of the community. Because this assurance could not always or sufficiently be given, governments have found that reserves or bases of gold and silver behind their paper or token currency added stability to their financial systems.
It is this attitude that gives rise to the implicit assumption that — somehow — the monetization of junk debt doesn’t matter, and that a dollar is a dollar is a dollar… Apparently, when the market displays distaste for an asset, that’s bad for everyone, but when it proceeds to the never-never land of the central bank balance sheet, it’s ok again.
But when the paper goes POOF!
So, given our great distaste for the practice of monetizing debt (whether that debt is the national one or not), the question remains; what really matters for long-term investments in currencies? Or, if you will, what is the inevitable means of reconciliation in the currency markets? Perhaps, we put forward; the answer to this lies in the reconciliation of the swings in the degrees to which various fiat currencies are ‘backed by gold at market prices’. Or, in short, it lies in asking the question: ‘What if the paper were to go POOF?’
The History between the Japanese Yen and the Euro:
We have presented the metric of the ‘% Dollar backed by gold’ many times here on greshams-law.com. We update it on a weekly basis on the Long-term Charts page. Below is a chart of similar metrics for the Japanese Yen and the Euro:
Looking at the chart above, one finds that both the Japanese Yen and the Euro possessed the same levels of ‘% backing’ for a long period between 1999 to 2004. The market then proceeded to push the Euro up against the Yen to a peak of around 170 on the EURJPY in 2008. However, the degree to which the Yen was ‘backed by gold’ was several times larger than the degree to which the Euro was ‘backed by gold’. Meaning, the pressures for the Euro to depreciate against gold were ultimately to be greater than the corresponding pressures in the Japanese Yen against gold. The reconciliations, as it were, came by the mechanism of a fall in the EUR vis-a-vis the JPY. The interesting thing, is that the enormous disconnect between the Yen and the Euro is yet to be reconciled (courtesy of relatively greater balance sheet expansions in the Euro Area when compared to the Bank of Japan)!
The End Game: Reconciled + more courtesy of herd spirits?
Here we see interesting valuation metrics, a clear price trend and an idea that is slightly off-the-beaten path. Perhaps we’ll see the reverse scenario (greater % gold backing in the Euro) at the end of this price trend courtesy of herd spirits?
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012