Tremors in the financial world.

On June 2, 2013 by Phil Champagne

By Phil Champagne, Managing partner at Wren Investment Group, LLC

If told you a while back that a little country such as Greece was having an economic collapse, I’m sure you wouldn’t think too much about the impact on the world markets, and somewhat rightly so. However, if I was to tell you that the 3rd biggest economy in the world was going into a collapse, how bullish would you be about the world economy in general? This is what is going on in Japan.

The term “Dr Copper” is used to refer to the price of copper as a good indicator of worldwide economic trend. If it goes up, it signals the world economy as a whole will grow. Equivalently I think we could talk about “Dr Diaper” as an indicator of age demographics of a country, and consequently how much pressure to expect on the social services to support it. A few months ago, for the first time ever in Japan, more diapers for old adults have been sold than for babies. Not surprisingly, the Japanese expense on their social security is growing faster and putting pressure on the government deficit. While the Japanese sovereign debt, at an astonishing 230% of their GDP, has been steadily growing, the interest rates have kept going down, maintaining an interest expense at about the same level. But recently the pressure is starting and interest rate on the Japanese government bonds have kept going up for the past few weeks and now the government expenses are going up. Higher government expenses means higher deficit, hence faster rate of increase of the government debt.  I invite you to read this article from the Telegraph.

http://www.telegraph.co.uk/finance/economics/10092023/Japans-problems-could-make-the-eurozones-look-like-a-garden-party.html

The Japanese government has clearly stated they intend to maintain the current policy of devaluing the yen and maintaining low interest rate for quite a while. This has in turn allowed the yen carry trade to resume its trend, where investors borrow Yens and invest them either in the Japanese equity market or abroad, which is plunging the value of the yen.

Some of that money was invested here in the USA, more specifically in the equity market. The low interest rate environment in the US is a contributor. An alarming effect of all this is the 10 year Treasury bond has been constantly going up for the past few weeks. See the 10 year treasury bond weekly chart below. (Each candles represent one week of trading)

TNX-May31-2013

Rising rate would put pressure on other investments, particularly real estate which is very sensitive to interest rate. Central bankers are trying to manage market expectation as much as possible by playing a combined chess and poker game to maintain the illusion of control while they manipulate the price of money: interest rate. If rates keep going up , we will have a market crash. On the other hand, if they increase QE+ so to maintain the rate below that level, they invite more bubble and more price inflation to come (commodities going up). If they stay the current course, these raising rates will lead to a major crash. So what an investors can do? Not only does an investor has to guess how the economy would do but he needs to second guess what the central bankers will plan to do.

In such environment, it is important to look for a sound investment. Precious metals are your absolute protector while sound real estate investment protects you from rising price inflation.

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