One of the Greatest Currency Moves of All Time

Dear A-Letter Reader,

The Forex market is, without a doubt, the largest market in the world - and the most liquid.

As much as US$3 trillion a day trades in the currency market, more than all of the world's stock markets combined.

Moreover, about 80% of all that trading is in seven major currencies, meaning that the volume in each of the majors is massive.

Overall, the currency market is the most critical market to support global trade and international transactions.

But what I like most — and one of the reasons I specialize in this market — is that there's always a bull market in currencies. That gives you the power to make money regardless of what's happening in the world.

Whether the stock market is sinking or soaring, whether real estate is booming or busting, whether interest rates are flying or falling, and regardless of the direction of bonds or commodities.

No matter what's happening, opportunities abound in the currency market.

The reason is simple: Currencies are different from stocks, bonds or commodities in that they let you make money by buying and selling one currency against another.

It's like a seesaw. When one is going down, the other one has to be going up. So there are always currencies going up. There is always a bull market.

Plus, equally important is the fact that currencies move independently from stocks and bonds. They are non-correlated. For the average investor, that means currencies are a great asset class for diversification.

Moreover, unlike the wild days of yesteryear, you no longer have to open big accounts or take huge risks to trade in this market. Two new revolutionary vehicles — currency ETFs and the Philadelphia Exchange's World Currency Options — now make it possible for average investors to trade currencies as easily as any other ETF or option.

The greatest advantage of all? The profit potential thanks to three factors: Big moves, potentially huge leverage and strictly limited risk.

And right now, that four-letter word RISK is something you want to pay special attention to. Reason:

Global Liquidity Is Deteriorating Badly

Last week, Former Fed Chairman Greenspan declared that the ongoing credit crunch is "identical" to the crisis of 1998 — when Russia defaulted on its debt and the giant hedge fund Long-Term Capital Management came to the brink of collapse.

I disagree. It's actually a lot worse.

The primary source of today's crisis — the mortgage meltdown in the U.S. — is far larger than the source of the crisis in 1998.

The number of hedge funds and other institutions involved is hundreds of times greater.

Most important, in my view, the borrowing of low-interest Japanese yen to buy high-risk investments (the "yen carry-trade") is many times larger.

And now, it seems U.S. Treasury Secretary Hank Paulson shares my view. Indeed, this week Paulson warned that:

• We have a severe crisis of confidence in credit markets.
• It is likely to last longer than previous financial shocks of the past two decades.
• It could even last longer than the turmoil that followed the 1998 crisis or Latin American debt crisis of the 1980s!

Good. At least someone besides us realizes this isn't an isolated pain that a couple aspirin can alleviate.

And fortunately, your portfolio doesn't have to just lie there suffering. There are plenty of profits to be made as long as you know where to look.

One of my favorite vehicles: Japan's currency, the yen. Let me explain why ...

Dust Off Your "De Lore-Yen,"
We're Going Back in Time!

Let's step back in time to 1997-1998 and focus on the Asian Financial Crisis.

That sparked one of the greatest and sharpest rises of any major currency in modern history — the yen was up 20% in just one month, and much more as the year progressed.

Reason: I have a feeling we could see a move of similar (or even greater) proportions very soon.

What was the big force behind the yen's powerful surge back then?

It wasn't economic growth — the Japanese economy was still suffering from an on-again-off-again recession that began earlier in the decade.

And it certainly wasn't the attraction of high interest rates, inasmuch as the Bank of Japan had been pushing rates sharply lower, maintaining a zero-interest rate policy.

Rather, the yen surged during the Asian Financial Crisis because of a surging worldwide aversion to RISK!

Let me explain.

In the 1990s, Japan slashed its interest rates practically to zero. So investors in the U.S. and elsewhere got the brilliant idea that they could ...

1. Borrow Japanese yen at lower interest rates...

2. Convert them into dollars or other currencies...

3. Invest in higher-yielding, higher-risk instruments, and...

4. Make a fortune!

That's the "yen carry-trade" - using borrowed yen to finance your investments in dollars and other currencies. And back in 1998, close to US$140 billion was involved in this transaction.

But as soon as the crisis hit, investors scrambled to reverse the transaction:

1. They started losing a fortune on their higher-risk investments in the U.S. and elsewhere.

2. They rushed to sell them...

3. They bought Japanese yen to pay back the money they had borrowed from Japan, and...

4. They drove the value of the Japanese yen through the roof!

That's why the yen surged 20% in just one month. That's the powerful force that created one of the greatest moves in currency of all time.

Back to the Present

Now, I expect the same thing to happen again this time around, and possibly on a much larger scale.

Not only is the credit crunch bigger and longer lasting, as Treasury Secretary Paulson himself said recently. But the amount of money involved in the yen carry-trade — estimated at US$1 trillion or more - is about seven times greater.

Plus, there's another side of the story no one seems to be telling:

Japanese investors themselves are getting scared, so many are repatriating their money invested overseas.

U.S. and other international investors aren't the only ones who have hopped on the carry-trade bandwagon. Domestic investors in Japan are also a big part of this phenomenon: They've been just as quick as anyone else to borrow yen and invest it outside the Japanese archipelago.

Few analysts have paid much attention to this side of the story, perhaps because Japanese investors have typically been slower to run from their overseas investments. But that could be changing very quickly.

A catalyst: Just last week, Japanese Prime Minister Shinzo Abe resigned after his Liberal Democratic party was defeated in elections for the Upper House.

That leaves Japanese investors wondering if their government will now have trouble supporting the economy. Enough of a shock to alter the risk-appetite among investors in Japan? You bet!

In fact, that trend may have already been under way well before Abe's resignation. According to data from Japan's Ministry of Finance, Japanese residents sold more foreign equities than they purchased - to the tune of 273.3 billion yen (US$2.24 billion) - this past July. Then, in August, sales of foreign bonds outpaced purchases by more than 690 billion yen (US$5.8 billion).

Year to date, Japanese residents are also net sellers when it comes to transactions in international securities, quite a departure from the prior two years when the Japanese were largely net purchasers.

And remember: When the Japanese (or anyone else) are investing in foreign securities with yen, they have to sell their yen to convert into a foreign currency, driving its price down. So all their overseas investing in recent years contributed to yen weakness.

Conversely, now it's the opposite: When they unload their foreign investments, they have to buy yen to bring their money back home, driving the yen's value up. And all this money repatriation by the Japanese is another big factor that should contribute to yen strength.

There's a pattern emerging: As risk continues to find its way back into global financial markets, we could see the floodgates open and a tidal wave of investors all over the world rush to buy yen.

The net result: Don't be surprised to see a yen surge that rivals - or exceeds - its massive rise of 1998.

Your action: Seriously consider investments that will help you profit from the rise, such as Rydex's Japanese yen ETF. And using the Philadelphia Exchange's new World Currency Options to play this move could enhance your profit potential even more.

Want more info and instructions on this hot area?

No problem! Join me in our FREE Emergency Video Summit on the Web tomorrow at 2 PM EDT. (To register, visit this web page)

JACK CROOKS, Editor
World Currency Options

Greenspan Tells All - a Little Late

In Hans Christian Andersen's fairy tale, two fraudsters convince a gullible emperor that they are weaving him a beautiful new outfit, when in fact they are weaving him nothing at all. It takes a small, innocent child to point out that the emperor is in fact nude as he parades down the avenue.

Well, no one would ever call Alan Greenspan totally innocent, although he is small in stature, although certainly not in influence. As chairman of the U.S. Federal Reserve for nearly two decades, he has just published a long-awaited memoir that is harshly critical of President Bush, Vice President Dick Cheney and the Republican-controlled Congresses of recent years. He says the GOP abandoned their party's conservative principles on spending and deficits and harmed the national economy for years to come with continuing deficits.

Well, duh! Hardly a breaking news story, except that it is Greenspan who says it. But why wait until now? It seems a little late after all those times when he might have made the same point to stop all that orgy of Republican spending and deficits.

In the 500-page book, "The Age of Turbulence: Adventures in a New World," Mr. Greenspan describes the Bush administration as so captive to its own political operation under Carl Rove that it paid little attention to fiscal discipline, throwing out the party's long standing allegiance to balanced budgets and pay-as-you-go spending.

Perhaps Greenspan's toughest criticism: "They [the Republicans] swapped principle for power. They ended up with neither. They deserved to lose" in the 2006 election, when they lost control of the House and Senate, he said.

There is no doubt, based on polls of Republicans, that one of their greatest disappointments in the Bush administration has been the huge deficits and new entitlement programs they proposed, such as the trillion dollar Medicare-Medicaid drug program for seniors.

Indeed, President Bush has never vetoed one bill based on excess spending, allowing Republicans in Congress to add thousands of pet project earmarks to numerous appropriation bills, running into many billions of dollars. So rampant has been this spending, the earmarks became a national scandal and political issue skillfully used by the Democrats in the 2006 elections.

Some economists argue that Mr. Greenspan deserves considerable blame for the current deficits. Not only because he failed to speak out in a timely fashion, but because the Fed slashed interest rates to rock-bottom lows and kept them there for three years after the stock market collapse and the recession in 2001.

Greenspan has long been known as a libertarian and a Republican, indeed in his youth he was a disciple of the late Ayn Rand, the founder of the so-called "objectivist" movement and a stout defender of the gold standard backing for the U.S. dollar. But once in power at the Fed, he showed great facility for getting along with free spending presidents, without criticizing them. He even endorsed President Bush's tax cuts which undoubtedly have contributed to the massive deficits.

So Greenspan has pointed out, 18 months after leaving office that the Republican emperor has no clothes when it comes to taxes and spending. But where was he when the GOP and the country needed him to speak? Jotting down notes for his future tell-all book?

If so, no doubt his belated stance will sell books.

BOB BAUMAN, Legal Counsel

Wealth & Investments

It's Fed Week!

Last week, the well-coordinated rally in global financial markets propelled U.S. stocks more than 2% higher. As stocks rose, investors around the world waited for the Fed's response to the global credit crunch.

Of course the high-profile event of this week will undoubtedly be tomorrow's FOMC meeting when the Fed is widely expected to cut interest rates in the face of mounting evidence of a U.S. economic slowdown.

According to Bloomberg news, "Interest-rate futures show traders see a 58% chance of a half-percentage-point cut in the Fed's target for the overnight lending rate;" that probability has increased sharply from virtually ZERO chance of a hefty half-point cut just one month ago.

Still, the Fed's most likely course of action would be a "measured" half-point cut in fed funds to 5%. That could be followed by a more intense "monitoring of incoming data" on the economy before it moves to ease rates by another quarter-point in the near future.

Whatever the actual policy action, it's worth remembering that the Fed has historically moved interest rates up and down in broad cycles. That means that even just a quarter-point rate cut tomorrow is likely to be only the first of several similar moves.

The last time the Fed made a rate move - any move - was June 2006 when it hiked fed funds a quarter-point to 5.25%. That was the last of 17 straight rate increases over a two-year period that began with a benchmark rate of just 1% back in June 2004.

However, the Fed finds itself between a rock and a hard place when it comes to interest rate easing, whether "measured" or not. In point of fact the Fed is caught between a plunging dollar on the one hand and the possibility of recession on the other.

Falling interest rates may help prop up the economy, but should put the dollar under even more intense selling pressure.

Last week, the greenback fell within a penny of its record low against the euro, and notched a fresh 30-year low against the Canadian dollar. And the ongoing yen carry-trade unwind has led to the biggest dollar decline against Japan's currency in more than a week.

If we are in store for a "slow and steady easing cycle in the U.S.," according to one analyst quoted by Bloomberg, and "interest-rate differentials return to drive currencies and the Fed is likely to ease relatively to other countries, there's a lot of capacity for dollar selling from institutional investors."

It should be an interesting week...oh and Wall Street's major brokerage firms including the much beleaguered Bear Stearns are set to report their latest quarterly financial results this week too...warts and all! Look for more on the profit outlook for brokers here in the A-Letter coming soon.

MIKE BURNICK, Senior Editor & Global Markets Analyst

EDITOR'S NOTE: You can hear more of Mike's thoughts on the latest Fed action by tuning in to Ring Side Politics radio program with Jeff Crouere tomorrow at 7:30 AM EDT. You can listen live at: www.ringsidepolitics.com.

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