This is the portfolio shifting aspect.

It’s like if the corn crop dies and consumption remains the same, which would drive up the price.

But someone with a huge warehouse full of corn decides to sell it.

The price can go down until that warehouse selling winds down, and then the crop failure aspect takes over.

TOKYO (Nikkei)–Japanese retail investors fled euro-denominated assets in May as Europe’s fiscal troubles dragged on.

The balance of publicly offered euro-denominated investment trusts plunged to 3.92 trillion yen in May, down 14.3% on the month, according to data released Friday by the Investment Trusts Association, Japan. With the decline, euro funds became the third-most favorable type of foreign-currency investment trust — being passed for the first time ever by Australian dollar funds, whose balance slid 9.9% to 4.9 trillion yen.

U.S. dollar funds remained the most popular, with 9.76 trillion yen in assets.

Assets in foreign currencies as a whole fell 8.2% to 27.52 trillion yen.

The balance of all publicly offered investment trusts came to 60.5 trillion yen, down 7.5%.

The steep decrease in the value of euro-denominated assets prompted investors to keep taking their money out of such funds. Investment trusts that mainly target European stocks and those invested in bonds denominated in European currencies marked their 33rd and 20th straight months of fund outflows in May, according to the Nomura Research Institute.

6 Responses

  1. “It’s like if the corn crop dies and consumption remains the same…”

    The European gov’ts will still have deficits, only not as large as in the past. So the corn crop will not die, it will still grow larger.

    100% of taxes get spent by the gov’ts, so there really isn’t any “consumption” of money, is there?

  2. The selling of periphery euro assets, but not necessarily a flight into German assets — as perhaps those are already fairly valued — would put continued downward pressure on the euro even with the deflationary policies.

    Particularly if the market begins to believe that the EMZ will break up, with the periphery converting euro debts to their own currencies.

    1. “The selling of periphery euro assets…would put continued downward pressure on the euro…”

      Selling of euro assets puts upward (not downward) pressure on euro, because sellers of those assets demand euro in exchange for those assets.

      It’s the repatriation of funds from euro to yen, that drives euro down, no?

      1. No, by “downward pressure on the euro”, I am referring to price of the euro in terms of USD or some other reference currency. The selling of debt would put downward pressure on the yields, but you do not “run out” of currency with which to buy debt, because currency is not destroyed when it is used. This would not make euros scarce in proportion to dollars.

        What would make them scarce would be an interest rate parity argument, assuming the high yields of periphery debt — except that those reflect default risk, and so you can’t compare them to risk-free USD yields in your IRP calculation. The assumption of deflation combined with an interest rate parity argument is basically Warren’s point, but that’s a very tricky point to make — it’s not at all clear that any deflation in the EZ is going to be high enough to offset the default risk.

        So if the portfolio shift is to sell periphery debt and buy German debt, then yields on periphery debt rise, yields on German debt fall, but nothing happens to EURUSD modulo these IRP arguments. But unless the increased default risk in the periphery somehow reduces the risk of default in the core, or increases returns in the core by an equivalent amount (unlikely), then much of the portfolio shift will be to sell periphery debt, sell euro for USD (or Yen, etc.) and buy treasuries/JGB. And this is a source of the downward pressure on the euro.

        Again, one of many cross-currents. Another cross-current is the dollar liabilities of euro banks. And of course the EUR is overvalued on a PPP basis, and has been for years.

      2. “…I am referring to price of the euro in terms of USD…”

        Increase in demand for euro, will cause it’s value to appreciate relative to everything. It doesn’t matter where the demand is coming from, does it?

        “The selling of debt would put downward pressure on the yields…”

        Selling of debt means that the supply of debt on the market increases, so the price of debt goes down, which means the yield goes up, no?

      3. Curious, for the second point, yes, I should have said “prices” not yields.

        For the first point, no, there is no increased demand for euros as a result of people rotating out of one euro asset and into another. For example, if the demand shift is Greek Debt –> German Debt. Euros would be used to settle the transactions in both cases, and there would be no net increased demand for them. So you need to know what asset people are buying, not just what asset people are selling.

        My point was that if the portfolio shift is Greek Debt –> U.S. Debt, then you would see an increased demand for dollars relative to euros, since you need to sell euros and buy dollars in order to make the shift.

        And the reason for believing that this shift is occurring is the large amount of periphery debt in comparison to the core debt, as well as the fact that deflation in the periphery is also bad for the core — the core debt is not risk free, either, and default risk in the core increases as things get worse in the periphery.

        What we are seeing is capital flight from euro assets generally, not a portfolio rebalancing from one euro asset to another.

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