I have written about depreciating the dollar before. Here is some recent supporting and related news from our friends in Europe and Japan….

In Europe, something odd is happening. The recently-weaker Euro currency is allowing Germany to experience a mini economic boom. Last week, Germany announced its fastest quarter of economic growth since 1990. I recall writing in a client newsletter about the potential for this to happen months ago, and how if it happened, it would be short lived. This German economic blip proves my assertion that we’re living in a proverbial “race to the bottom” whereby countries are trying to depreciate their currencies against each other to make their exports cheaper and more competitive. The weaker Euro currency caused by a European banking and sovereign bond collapse this spring is allowing Germany to profit and grow. This -by the way – is exactly what we’re competing against and what we’re going to do in the US: depreciate the dollar so we can compete easier.

But the good news is not uniformly spread across Europe. The PIIGS countries (Portugal, Italy, Ireland, Greece, and Spain) are seeing continued economic weakness despite the weaker Euro, and the cost of insuring their debt is rising again. Mind you, things aren’t as bad as they were back in May. Europe is not in a panic again. Yet. But I want to point out that this week saw a spike in overnight lending from the European Central Bank -the ECB- to banks, and that the level of lending is the highest since the panic this spring. Also, the cost to insure Ireland’s debt rose 45% in the past few weeks. The rest of the PIIGS -even Italy – have seen the cost to insure their debt rise noticeably in the past few weeks. That’s the bond market telling European governments -and the ECB- it has less confidence in their economic recovery, that the bank stress tests were a sham, and that they are noticeably more concerned that bond investors will be paid back. Case in point: the cost of insuring Greek debt is discounting a 40% chance of default in the next 5 years. Personally, I’m forecasting more like a 70-80% chance, and that it will happen in the next 2 years when the great chase to issue $ Trillions in sovereign bonds in the US & Europe will peak. This intense competition for buyers will cause someone to be left out in the cold with no one buying their bonds. Greece looks weak enough.

I give some weight to the argument that that the PIIGS countries are seeing their bonds come under pressure largely because their economies have not shown much in the way of recovery whereas Germany’s has. So by comparison, they look weak. If the PIIGS country’s economic recovery looks weak enough, there will be rising fear among investors. When this happens, they’ll pile into historically safe-havens like US Treasury bonds, German bunds, and British gilts. This in turn causes those safe haven bond prices to rise (a la supply & demand), and the yield (or interest rate) falls. So as German bond yields fall and German bond prices rise, this makes bonds from the PIIGS countries look ugly by comparison. Either way, Europe, you get what you get. The Euro currency project has Germany at its core and includes the PIIGS countries that are financial basket-cases. All countries in the Euro have to compete with Germany since they can’t depreciate their own national currency anymore. That’s the deal they struck when they signed up for the Euro. Based on the strength of the German economy, the PIIGS countries got an unjustifiably cheap ride from bond markets for many years. They gorged themselves on cheap bonds rather than use that money -and time – to implement structural economic reform to position themselves to compete. Now its time to shut off the cheap money spigot and see who can raise money without relying on the German balance sheet. Don’t be surprised when it’s obvious that none of the PIIGS can compete without leaving the Euro project, defaulting, and re-issuing their own currency.

Now the self trash-talking Japanese: The Japanese currency is a safe-haven not unlike the US dollar. So if Germany had a fantastic Q2 largely because the Euro currency depreciated suddenly, then what would you guess happened in Japan during this same time ? Answer: since investors fled Euros, they ran to the Japanese Yen. That pushed the Yen up and was the reverse process seen in Germany. With that in mind, it should not surprise you that the Japanese economy suddenly slowed in Q2 to a 0.1% growth rate — a measly 0.4% annualized pace. Basically a flatline. This comes after a 1Q which saw the Japanese economy grow at a 4.4% annualized pace. Another result of the sudden surge in demand for Yen is demand for Japanese sovereign bonds rose, causing yields to fall. 10 year Japanese gov’t bond interest rates dropped under 1%. There’s some perspective for you: earning 0.9%/year interest to lock up your money for 10 years. For comparison, US 10 year Treasury Bond yields have fallen to the 2.6% range. Based on this argument, 10 year Treasury bond yields could head lower. That means the 10 year Treasury note price could go higher.

To be fair, a large part of Japan’s 1Q big economic growth was the tail end of a sugar-rush impact of stimulus packages around the globe. This situation also speaks to how rapidly a large economy can slow when magical monetary and fiscal steroids are stopped. Naturally the rising Yen is making Japanese exports more expensive and thus harder for the Japanese to compete internationally. So you can guess what Japanese politicians are doing: they’re busy trash-talking their economy in an effort to convince international currency speculators and bond buyers to stop buying their currency and thereby driving the value up. They should be careful what they wish for because before too long (probably next year or the year after), the Japanese government will be forced to do an about-face and attract international bond buyers in a larger way to help fund their budget deficits. Currently only about 5% of Japanese Bond buyers are from outside Japan. That will change radically in the coming years because Japanese demographics are terrible: there aren’t enough young people to drive the economy forward, and there are too many pensioners that will begin redeeming their Japanese bonds instead of buying more.