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In the summer of 2007, Bear Stearns confessed it had spent $3.2 billion bailing out two of its funds that were exposed to the sub-prime market. At the same time, the yen carry trade marked its top. Soon thereafter, Bear Stearns went belly up, and the needle on the world’s sentiment shifted towards risk aversion.
Investors who had enjoyed a handsome return from borrowing cheap yen and using that yen to buy high-yielding currencies like the New Zealand dollar, the Indonesian rupiah and the Australian dollar went running for cover! They quickly found that the yen carry trade was like picking up pennies in front of a steamroller …
The success of this trade was highly correlated to the world’s dependency on easy credit. So when the warning signs started flashing that the credit bubble was bursting, the yen soared as investors fled those higher-yielding investments and bought yen to exit their trades.
As a result, since June 2007, the yen has gone up 28 percent against the dollar, its main trading partner.
Adding to that disadvantage, the yen has been exceptionally strong against the currencies of Japan’s key Asian competitors …
Since the middle of 2007, the yen has climbed:
- 20 percent against the Chinese renminbi (or yuan),
- 21 percent against the Singapore dollar,
- 25 percent against the Thai baht,
- 31 percent against the Indonesian rupiah,
- And 43 percent against the South Korean won.
That’s a distinct position of weakness for the Japanese because it makes their exports significantly more expensive than their Asian competitors’. Of course, this is horrible news for an economy where exports make up 16 percent of total output! And even with improvements in the global economy, Japan’s exports are still down 37 percent from this time a year ago.
This is why Japan has experienced the worst contraction of all major economies and is expected to have the weakest recovery. And that’s why there is speculation that Japan could return to recession — as soon as the fourth quarter of this year.
Will a New Ruling Party in Japan
Strengthen the Yen?
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| Hirohisa Fujii revised his initial remarks about the yen. |
Japan’s new ruling party, the Democratic Party of Japan, entered office last month. And the newly-appointed finance minister, Hirohisa Fujii, was happy to publicly comment on exchange rates.
But his initial remarks that a strong yen could actually be good for the economy caught the markets by surprise and sent the yen soaring even further …
Japanese exporters strongly disagreed with him. So the finance minister was reminded that when he said “good” perhaps he should have said “bad.”
Since then, Finance Minister Fujii has done an about face, joining other major countries with verbal threats against the strength of their respective currencies (in relation to a weakening dollar).
This means that as the U.S. dollar continues to give back its gains from last year’s crisis-driven flight to safety, the possibility of currency intervention by countries like Japan increases.
Japan’s Previous Yen Intervention
Japan has a reputation for being sensitive to movements in the currency markets and for taking action. Its heaviest periods of intervention tended to coincide with slower economic growth rates — like it’s experiencing now.
The last time Japan intervened to weaken the yen was between 2003 and 2004 …
Over the course of 126 days the Ministry of Finance purchased $315 billion and sold yen in the open market. These steps ultimately sent the yen 11 percent lower.
But the overall success of interventions in changing the long-term path of a currency is not great. A lot depends on how it’s done …
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| Manufacturers and exporters would welcome an intervention weakening the yen. |
Changing the path of a currency tends to have a higher success rate when countries act together in support of (or against) the same currency. These coordinated interventions also have a greater spillover effect on other currencies.
Last weekend, leaders from the G-7 met in Istanbul. Although all G-7 members have made increasingly frequent individual statements about currencies, the G-7’s collective message on currencies didn’t change! It was identical to its communiqué of April that said:
“Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate.”
So when you consider the theme of coordination in the policy responses to the global crisis, if a major currency intervention takes place, the probability of a coordinated response in currencies is high.
And for Japanese exporters dealing with a yen near 14-year highs against the dollar … that would spell relief.
Regards,
Bryan
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