The yen fell to a three-month low against the dollar and weakened versus the euro before government reports tomorrow that may show rising unemployment and falling consumer prices in Japan.

Was deflation ever really whipped in Japan ???

Its return, then, is hardly a surprise. And policy makers’ ability to fend it off remains doubtful. Japan and its companies are familiar with what this means: consumers delay purchases; real interest rates rise; earnings for all but the most defensive companies erode; and wages stagnate.

Because fuel prices spiked in 2008, the core consumer price index, which excludes volatile fresh food, rose 1.5%; not high by most standards. Now, economists are forecasting a clear resumption in deflation. Friday’s January core CPI is expected to slide 0.1% on year.

This time, adding to the downward spiral of prices and wages is a collapse in exports and the prospect for deflation to turn up in the U.S. and China. This makes a recovery in profits even more difficult.

As before, the Bank of Japan finds itself unable to react strongly with conventional methods; short-term interest rates are already near zero. Unconventional methods don’t sit well with the conservative BOJ.

Crucial to breaking the downward cycle is changing the expectation — among companies and shoppers alike — that prices will keep tumbling. On this front too the BOJ has already laid down its sword. Its own price-stability band, a range of acceptable price changes, starts at zero. That’s compared to a range of 1% to 3% for the BOJ’s peers.

And an administration struggling just to keep its grip on power offers little hope that it’ll be able to spur demand.

As Nassim Taleb explains : “I fully agree that incentives are the heart of capitalism and free markets – but certainly not that incentive scheme.

In fact, the incentive scheme commonly in place does the exact opposite of what an “incentive” system should be about: it encourages a certain class of risk-hiding and deferred blow-up. It is the reason banks have never made money in the history of banking, losing the equivalent of all their past profits periodically – while bankers strike it rich. Furthermore, it is that incentive scheme that got us in the current mess.

Take two bankers. The first is conservative. He produces one annual dollar of sound returns, with no risk of blow-up. The second looks no less conservative, but makes $2 by making complicated transactions that make a steady income, but are bound to blow up on occasion, losing everything made and more. So while the first banker might end up out of business, under competitive strains, the second is going to do a lot better for himself. Why? Because banking is not about true risks but perceived volatility of returns: you earn a stream of steady bonuses for seven or eight years, then when the losses take place, you are not asked to disburse anything. You might even start again, after blaming a “systemic crisis” or a “black swan” for your losses. As you do not disgorge previous compensation, the incentive is to engage in trades that explode rarely, after a period of steady gains”.

This mismatch between the bonus payment frequency (typically, one year) and the time to blow up (about five to 20 years) is the cause of the accumulation of positions that hide risk by betting massively against small odds. As traders say, they have the “free option” on their performance: they get the profits, not the losses.

This vicious asymmetry  is the driving factor behind investment banking.

Underscoring the widespread weakness in the U.S. housing market, home prices in 20 major cities dropped 2.5% in December from the prior month and were down a record 18.5% from the final month of 2007, according to the Case-Shiller home price index published Tuesday by Standard & Poor’s.

Years of appreciation have been wiped out, with average home prices standing back at levels similar to those seen late in 2003

How far are we from the bottom ?

As we can see in the graphics above, prices still far away from long term average prices !!!

After Penélope Cruz won for best supporting actress for her role in “Vicky Cristina Barcelona,” she gave part of her speech in Spanish — she said backstage it was a dedication to the actors and people of Spain — and then suggested backstage that the movies had to grow beyond the bounds of strictly American stories. “We are all mixed together, and it has to be reflected in the cinema,” she said.

Congratulations PE.

No new wave of protectionism yet…  

To be fair, while protectionist sentiment and pressures are rising, there is so far little hard evidence of a new wave of protectionist measures.  In a recent media interview, WTO Director-General Pascal Lamy noted that “nothing dramatic” had happened in terms of an increase in protectionism since the start of the crisis in the autumn.  Still, there have been some cases of increased protectionism that might mark the beginning of a new trend.   

Some recent examples include increased state aid to particular industries, most notably the domestic auto industry in a large number of countries (e.g., the US, Germany, France, China, Canada, Australia, Sweden, Russia), tariffs on steel products in India, higher tariffs on 940 products in Ecuador, and other protectionist measures in Indonesia, Argentina, Korea and the EU. 

Moreover, in several countries, governments are leaning on banks that have received capital injections or guarantees to lend predominantly to domestic households and companies rather than financing projects abroad.  With the recession deepening and broadening, further defensive action is likely to be taken by many governments. 

But let´s remember what happened before :

For sure not to be re done !!!

“Dmitry Medvedev, the Russian president, accused Vladimir Putin’s government on Friday of failing to act quickly to combat the economic crisis.It was a further sign of growing friction between Russia’s two power centres” has said FT today.

Friction gets louder as Global meltdown runs its way…

Hungarian, Polish and Czech government debt, among the highest rated in emerging markets, has already been downgraded by bondholders.

Investors are demanding 20 basis points more yield to own Hungary’s bonds than similar-maturity Brazilian debt, which is rated four levels lower by Moody’s Investors Service, JPMorgan Chase & Co. indexes show.

The risk of Poland defaulting is about the same as Serbia, ranked six levels lower by Standard & Poor’s, based on credit-default swap prices. Czech 10-year bonds yield the most compared with German bunds since 2001.

Investors who lost more than 18 percent on emerging-market sovereign and corporate bonds last year based on Merrill Lynch & Co. indexes now face steeper declines in Eastern Europe. While the region’s integration with the European Union spurred foreign investment earlier this decade, Poland’s currency weakened 35 percent against the euro since August, the Czech economy cooled to the slowest pace in almost 10 years in the fourth quarter and Hungary required a bailout from the International Monetary Fund.

Emerging Europe will post an average current account deficit of 4.1 percent of gross domestic product this year, more than double the 1.7 percent deficit in Latin America and trailing surpluses in Asia, Africa and the Middle East, according to Citigroup Inc. data on Czech, Poland, Hungary and five other economies the region.

How will Western Europe be affected by the implosion of the region, remains to be seen.

Protectionism is the economic policy of restraining trade between nations, through methods such as tariffs on imported goods, restrictive quotas, and a variety of other restrictive government regulations designed to discourage imports, and prevent foreign take-over of local markets and companies.

If we are not able to bring some improvements in the Global Meltdown ASAP, that is what we are going to face very soon.

Whether the governments are democracies, like those of the U.S., Western Europe, India, etc., or authoritarian, like that of China, or “in-betweens,” like Russia, the clamor “for saving local jobs and production will likely push them toward moves that will only heighten the downward spiral.”

That conjures up the images of Smoot-Hawley and all the horrors that odious legislation begot…

Financial Rescue May Cost More Than $1 Trillion, Mr. Geithner just said !!!

At the same time :

SP 500 crashed more than 3 %…

As we can see, markets are not very happy with the bailout plan…

Crude Oil – The Global Engine,Stalled and Flooded