“Great powers and empires are, I would suggest, complex systems, made up of a very large number of interacting components that are asymmetrically organized, which means their construction more resembles a termite hill than an Egyptian pyramid. They operate somewhere between order and disorder – on 'the edge of chaos,' in the phrase of the computer scientist Christopher Langton. Such systems can appear to operate quite stably for some time; they seem to be in equilibrium but are, in fact, constantly adapting. But there comes a moment when complex systems 'go critical.' A very small trigger can set off a 'phase transition' from a benign equilibrium to a crisis – a single grain of sand causes a whole pile to collapse, or a butterfly flaps its wings in the Amazon and brings about a hurricane in southeastern England.
“Not long after such crises happen, historians arrive on the scene. They are the scholars who specialize in the study of 'fat tail' events – the low-frequency, high-impact moments that inhabit the tails of probability distributions, such as wars, revolutions, financial crashes and imperial collapses. But historians often misunderstand complexity in decoding these events. They are trained to explain calamity in terms of long-term causes, often dating back decades. This is what Nassim Taleb rightly condemned in The Black Swan as 'the narrative fallacy': the construction of psychologically satisfying stories on the principle of post hoc, ergo propter hoc."
– Niall Ferguson, “Complexity and Collapse”
I see a bad moon a-risin’, I see trouble on the way.
I see earthquakes and lightnin’, I see bad times today.
I hear hurricanes a-blowin’, I know the end is comin’ soon.
I fear rivers overflowin’, I hear the voice of rage and ruin.
Don’t go ’round tonight, well, it’s bound to take your life.
There’s a bad moon on the rise.
– “Bad Moon Rising,” John Fogerty, Creedence Clearwater Revival, 1969
As a college student, I reveled in the sounds of the Creedence Clearwater Revival and its lead singer and songwriter, John Fogerty. Fogerty supposedly wrote “Bad Moon Rising” after watching the 1941 movie classic The Devil and Daniel Webster. The movie is a paean to freedom, the American dream, and the ability of a man, even one who has sold his soul, to find redemption. There is a scene involving a hurricane that supposedly inspired the song. Fogerty claims that the song was about “the apocalypse that was going to be visited upon us.” Barry McGuire had sung “Eve of Destruction” only a few years earlier. A generation that had grown up with the Cold War, the growing conflict in Vietnam, the free speech movement and a nuclear arms race was increasingly distrustful of adults and government. “Don’t trust anyone over 30” was the maxim first uttered by Jack Weinberg, a leader of the free speech movement in Berkeley. In a small bit of irony, the founders of that movement recently gathered to celebrate its 50th anniversary. As a side note, I find that Boomers are far more susceptible to talking apocalypse than our kids are.
Well, it’s a beautiful night here in Dallas, and there is no bad moon rising; but over in the Land of the Rising Sun, I do see a bad yen falling. As we will see in a minute, the recent yen price chart looks like a frozen rope (in the words of Jared Dillian). Understand, my bet (to use the word forecast would imply a level of precision in modeling that I have not attained) is that the yen goes to 200 against the dollar, so breaching 120 is not exactly a shocker to me. What is a little unnerving is the rapidity of the recent move.
In this week’s letter we’re going to explore some of the ramifications of the currency war that Japan is precipitating. It is more than just Germany, Korea and China having issues and needing to contemplate their own competitive devaluations. If the yen goes too far too fast, there will be geopolitical repercussions far beyond the obvious first-order connections. As Fogerty ended his song:
Hope you got your things together.
Hope you’re quite prepared to die.
Looks like we’re in for nasty weather.
One eye is taken for an eye.
I’ll try to see if I can help you “get your things together” … and help you prepare your hedges. We may indeed be in for nasty weather.
Bad yen falling
As I write on a Saturday morning, the yen is 117.8 to the dollar, having fallen modestly from the mid-118’s yesterday. ShinzŠ Abe was nominated to be Japanese prime minister for the second time on September 26, 2012, and it was clear that he would win. He implemented a program that has since come to be called Abenomics.
Japan was suffering from a 35% loss of competitiveness vis-à -vis their most important trading competitor, Germany, because of a rather steep rise in the yen (for reasons we will examine later). For the first time in generations, Japan’s trade deficit had gone negative. The interest-rate market was beginning to bounce around, which was a death knell for Japan. Abe made no bones about it: he would replace the controlling members of the Bank of Japan with members who agreed with him that massive quantitative easing should be undertaken.
In the graph below, notice that as it became clear that Abe would win, on cue the yen began a nosedive from 75 to the dollar to slightly over 100 to the dollar and then went sideways for about a year and a half. The Halloween 2014 announcement by the Bank of Japan to double down on its quantitative easing started the recent frozen-rope-like plunge, taking the yen almost straight down to 118 and on its way to 120 in very short order. Goldman Sachs has forecast that the yen will be at 130 by the end of 2015, 135 by the end of 2016, and at 140 by the end of 2017. That rhymes with the prediction of my friend Kiron Sarkar, whose target is 125 in the first half of 2015.
Make no mistake: the Japanese are not at all concerned that the yen is going to 130 or 140 or 150. While we tend to see the recent move as precipitous, it may be helpful to walk in the other man’s shoes, so to speak, and see the currency move from the long-term Japanese perspective. A little over 40 years ago the yen was at 350 to the dollar. Less than two decades ago it was at 150. Then it strengthened all the way to the mid-70s. Even if the yen were to eventually fall to 200, as I predict it will, that’s not even a 50% reversal.
Japanese industry has had to suffer the yen’s rising almost fourfold over the last 40 years. If the dollar were to rise as much, there would be much weeping and wailing and gnashing of teeth, and the usual suspects in the Senate would be up in arms about currency manipulation. Japanese businesses just cut costs and improved quality and competed heads up. Oh yes, it’s been nasty for the last two decades as their nominal GDP has been flat, but their corporations are still some of the most competitive in the world. You put a currency devaluation wind at Japanese corporations’ backs and watch how competitive they become. Cue serious worry from businesses located in Germany, Korea, and China.
continue reading: http://www.mauldineconomics.com/frontlinethoughts/on-the-verge-of-chaos
