Friday, February 23, 2007 Vol. 9 No. 47 In Today's Letter: Comment: Hints About Carry-Trade Risks Are Lost in Translation  Offshore: If You Like the IRS, You'll Just Love the UNRS! Wealth: For Japan: the Sun Finally Rises Hints About Carry-Trade Risks Are Lost in Translation Today's comment is by Jack Crooks, our Currency Director and Editor of Crooks Currency Options and Crooks on Currencies. Dear A-Letter Reader, In school many years ago, when I was first learning this finance stuff, I had a crusty old finance professor. The first day of class he stood at the blackboard and drew a sloping line running from the bottom-left to upper-right of the board. He said to us, "Ladies and gentlemen, this is the cornerstone of all financial theory. It's called the risk/reward curve. All things in finance flow from this curve." My crusty old professor knew nothing of the yen carry-trade or interlinked derivatives. None of that stuff even existed back then. Most likely, my old professor would never have dreamed that derivatives could create seemingly risk-free money out of thin air - and morph the risk/reward curve into a "reward/reward curve" in the minds of so many investors. Since the Bank of Japan (BoJ) is in large part responsible for the new "reward/reward" curve know as the yen carry trade, I find it interesting that they even remember the old risk/reward curve still exists.  "If interest rates were left unchanged, regardless of economic fundamentals, low-cost funds can create unnecessary and one-side positions. This could eventually trigger massive unwinding of such positions and distort market activity," Bank of Japan Governor Toshihiko Fukui said after announcing a 25 basis point hike in interest rates this week. Unfortunately those dipping into the BoJ punchbowl, like hedge fund managers, seem a bit too intoxicated with profits from continuously borrowing and selling yen to believe the yen carry-trade will ever unravel.  I use the word "unfortunately" because sooner or later this ticking time bomb of under pricing risk, due to easy access to such cheap money, will explode in the financial markets. Milton Friedman summed it up best when he quipped: "There's no such thing as a free lunch."  Yen Unraveling? "No way!" - says the Market If you've read some of my A-Letter comments over the last several months you know that I think the Japanese yen is ridiculously cheap. And even though the Bank of Japan hiked rates, the yen got even cheaper. With the gift of 20/20 hindsight, analysts say that traders focused on comments from the BoJ about an accommodative monetary policy going forward. Traders heard "accommodative monetary policy" and they translated that to mean: Japan won't hike rates again anytime soon. This emboldened more yen selling. But these same traders seemed to miss what the BoJ said about risk. In fact, I think everything the BoJ said about risk was lost in translation. The return of risk into the market is the primary reason why I believe the yen will rally. Interest rates could play a contributing role, but it's secondary.  Let's look at Governor Fukui's words again, "...low-cost funds can create unnecessary and one-side positions. This could eventually trigger massive unwinding of such positions..."   So assuming the BoJ puts away the blunt instrument of hiking interest rates to increase the cost of borrowing yen, what else can they do? Well, when such borrowed funds are denominated in cheap Japanese yen, the answer is simple. The BoJ can increase the value of the yen.  If the yen appreciates, the effective cost of borrowing increases, even if Japanese lending rates remain the same. And the more the yen appreciates, the more yen borrowers will have to pay. Given the massive one-way bet against the yen right now, any risk of yen appreciation, will cause yen borrowers to stampede for the exits and dump their positions. The resulting typhoon of money buying yen to reverse the curry trade would likely crest over many markets. The question is where might this yen appreciation come from? The market seems convinced such a yen appreciation can't happen. But it will happen. These distortions always have a way of correcting themselves. The only question is what will trigger it and when will it happen? No one knows. If anyone did, the one-way bet against the Japanese yen wouldn't be happening.  Here's one possibility I don't think the market is expecting--The Bank of Japan intervenes in the market to buy yen . Japan is sitting on a huge stash of reserves. I believe it's around the US$800 billion mark-give or take US$50 billion either way. This is a mighty stash of cash that could do some major damage if the BoJ used this leverage to intervene in the forex markets. And especially if the BoJ chose to coordinate this intervention with another central bank, say the European Central Bank, for example.  Why would Japan jump in the market to strengthen the yen when their companies benefit from such a cheap yen on the export side? Credibility is the answer. The European's are crying "Uncle!" to BoJ Governor Fukui-san. Germany, France, and Italy are getting hammered by the super-competitive, ultra-cheap yen. Europe is being flooded with Japanese cars. And global competition in machine tools can't be fun for Germany when it goes up against Japan. In short, the weak yen could snuff out European growth momentum even before it takes root.   The BoJ knows it is appearing a bit duplicitous in letting the yen weaken. For they have been quick on the trigger in the past to deploy their reserves in the foreign exchange market, selling yen, when it got too strong in the past. Consistency is part of a central bank's credibility. Believe it or not, serious central banks value credibility-though many times it doesn't seem that way. And if the BoJ truly believes growth in the carry trade is endangering the system, they may feel compelled to act. Central banks have a fiduciary responsibility to safeguard capital above all else. They know they shouldn't be in the business of making financial speculation appear risk-free. I believe the BoJ's not so subtle hint about the fate of the carry-trade has been lost in translation. The signs are all there...look for the yen to take off shortly. JACK CROOKS, Currency Director P.S. Crooks on Currencies members, look for a way to play the next big yen move...coming soon! Not a member? Click here to read my special report Advertisement There's Only One Affordable Investment Left It's the world's second oldest asset class, and it's finally made its debut on the New York Stock Exchange. For generations it belonged only to the realm of Fortune 500 companies and professional traders. But now thanks to the launch of 7 ridiculously simple (yet revolutionary) new products you - for the first time - can get in on it for just $79... Please click here for more information: http://www.isecureonline.com/reports/CRC/ECRCH210 Offshore If You Like the IRS, You'll Just Love the UNRS Think about it for a minute -- suppose instead of paying your taxes to the U.S. Internal Revenue "Service" (sic), you had to file with and pay taxes to the "United Nations Revenue Service." "Have you gone mad, Bob?" you're muttering to yourself. But hold on to your wallet, folks, indeed the UN does want the power to tax you and me. Over 60 years since its founding, the United Nations may have, on balance, done some good. But objective historians and observers would be hard pressed to create a short list of major UN accomplishments. So you shouldn't be surprised, (especially since I've have been warning you since 2002), that the UN wants to become an international IRS. Those worthies at Babel on the East River want to impose on the already burdened taxpayers of the world a new round of "global taxes" to finance the UN and its questionable programs. This insane plan would supplement annual assessments of dues from each nation with direct UN taxes on the world. In 2002 I reported about a UN conference held in Monterey, Mexico, that I called "the tax collectors meeting from Hell" where plans first were mapped for a UN "international tax organization," a one-world IRS. So horrendously wrong was this idea that I had hoped it would die a natural death. Soon after at the UN, lame duck French President Jacques Chirac called for just such world taxes, this time cloaked in fighting "world poverty." Chirac proposed an international tax be levied on arms sales and some financial transactions in a bid to eradicate poverty. (Are we supposed to forget that billions have been spent for this very goal in recent decades, most of it from the pockets of American taxpayers who finance U.S. foreign aid programs?) Chirac's ideas immediately were strongly rejected by the U.S. delegation to the UN. Speaking for the Bush administration, then U.S. Agriculture Secretary Ann Veneman said: "Global taxes are inherently undemocratic. Implementation is impossible". The U.S. also refused to sign or agree to a UN declaration endorsing Chirac's global UN taxes. Last year the valiant U.S. Rep. Ron Paul (R-TX) renewed the warning about this dangerous UN plan. Rep. Paul noted that that the UN wants is the "biggest power grab yet - independent tax raising powers. The UN is deeply committed to establishing this sovereign" power for itself, without scrutiny and direction of its large aid donors (namely the U.S.)." The UN wants to tax everything from airline tickets to aviation fuel and carbon emissions. Not to mention each and every international currency transaction. I agree with my former House colleague, the good Rep. Paul, who says: "Rest assured that the UN is absolutely serious about imposing a global tax." BOB BAUMAN, Legal Counsel Wealth/Investments For Japan: the Sun Finally Rises Global investors who think Japan has been a lost cause lately may want to start rethinking. Japan's stronger than expected economic data out recent tells me it's time to start paying attention to the Land of the Rising Sun. The case for investing in under-achieving Japanese stocks can now be made based on rebounding growth - at long last. Plus, at the moment, Japan Inc. looks pretty cheap compared to its high-profile Asian neighbors. Japan's economy expanded at its most torrid pace in three-years, according to 4th Quarter GDP figures out last week. Growth in the world's second-largest economy checked in at very fast paced 4.8% annual rate at the end of 2006. That's positively stunning considering Japan's poor performance in the past. What makes the headline numbers sound all the more convincing is a closer look at the details. Domestic personal consumption surged at a 4.4% annual rate supported by rising wages. Japan has long been forced to rely on its exports to post ANY economic growth at all, so this news looks especially positive for a sustained recovery with the domestic spending now finally on the rise. That's no doubt what the ministers at the Bank of Japan (BoJ) had in mind today also, when they hiked the official policy rate (akin to the U.S. Fed Funds rate) to a still low 0.5%. After taking this step to boost lending rates, delayed at the last central bank meeting in January, many economists see monetary policy on hold for the remainder of the year. Such expectations of policy stability tend to give both stock and bond markets a floor to rebound off - and Japanese stocks in particular look poised to do well in this faster growth, low inflation, stable interest rate environment - let's call it the Ginza Goldilocks scenario. That Japan is relatively undervalued compared to its Asian neighbors is an understatement. Last year, while Chinese mainland stocks rose to triple-digit gains and many other Asian bourses posted rich returns - Japan was the only major market in the region to under perform, rising barely 6% in 2006. But rampant price appreciation has turned many Asia ex-Japan markets, well pricey. And a closer look at Japan Inc. reveals a healthy market that may finally see big gains ahead. MIKE BURNICK, Senior Editor & Global Markets Analyst P.S. For more on this dramatic change in Japan's investment scene, click here to read my blog. Also, my colleague Eric Roseman currently has open offshore and domestic positions in Japan in our TSI portfolio. Make sure you're well positioned for more profit potential with these plays before Japan Inc. really takes off in the coming months. And if you're not currently a TSI subscriber, click here to begin taking advantage of these and other investment opportunities that come to you each month in TSI... Advertisement Join The New American Tax Revolt What if I said you could – legally – eliminate all or nearly all of your U.S. tax burden? That's right, I mean you might never, ever have to pay a single dime in U.S. taxes again...and there's nothing the IRS could do about it. It's entirely possible when you use a little-known strategy that I'm about to share with you today. To find out how you can effectively eliminate your U.S. tax burden, click below. 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