The never yending story
What’s at stake: The strength of the yen – which hit a 15-year high of Y83.35 to the dollar last week – has already played a big role in the battle between Naoto Kan, prime minister, and Ichiro Ozawa, his challenger. But the relevance of the issue is actually broader than the upcoming election since it questions the stance of the G7 and the G20 on forex intervention, poses the question of uncooperative actions in Asia, and ultimately asks Japanese policymakers the question of how much the exchange rate defines the growth model versus how much it is a consequence of it.
The safe-haven currency
Gwen Robinson notes that the “safe-haven currency”, the yen, is still riding strong despite Japan’s latest political turmoil, constant threats of currency intervention by officials and lacklustre economic data. Indeed, with the battle for leadership of the ruling DPJ party to be decided in a September 14 party vote, there is a real prospect that Ichiro Ozawa, challenger to prime minister Naoto Kan, will be able to make good on his pledge to intervene to curb the yen. Although MinFin Noda has suggested that their respective comments on the yen essentially meant the same thing, there is a strong perception that an Ozawa victory would mean looser fiscal policy and potentially quicker and more determined yen intervention.
FT Alphaville notes that amid the cacophony of opinion about the Japanese currency’s concerted rise against the dollar (to a 15-year high of Y83.60 on Tuesday before a slight dip to Y84.61 on Wednesday), the Economist’s “burgernomics” has a rather interesting take. As of late July, the price of a Big Mac in Japan, at Y320 ($3.78 under Wednesday’s exchange rate), represented an exchange rate of Y85.7 in implied purchasing power parity of the dollar. The actual yen/dollar exchange rate then was Y87.2 – meaning the Japanese Big Mac was 2 per cent under-valued against the dollar, according to the index.
In another post, FT Alphaville provides a graphical illustration of BoJ interventions over the last decade and concludes that large FX interventions may have slowed appreciation but haven’t turned it around. It also makes the point that given low inflation for the past decade, the Real Effective Exchange Rate of Japan is actually not as strong as the nominal USDJPPY parity suggests.
The emergency meeting
Tokyo Takes Blog goes over the emergency meeting of the BoJ on August 30th and describes it as a farce unlikely to produce any effects highlighting the difficulty to communicate convincingly about intervention without discussing fiscal expansion and monetisation which would be a more effective way of weakening the JPY.
Notayesmaneconomics’s blog write that the BoJ eased policy unwisely. After many rumours over the past week or so the Bank of Japan finally held an emergency meeting and decided to take some action. It decided to expand the size of a bank loan programme it has been running and also the maturity of the instruments. So we have a programme of 30 trillion Yen rather than 20 trillion and 6 month maturities as well as the previous 3 months. In effect the Bank of Japan is offering Japan’s banks some 10 billion Yen in 6 monthly loans which translates to 116 billion US dollars at current exchange rates. Unfortunately this is an expansion of a scheme which is failing to have much impact. It was introduced last year and was previously expanded in March but I am not sure if anybody really believes it has done much good.
“Appropriate actions” for effective interventions
The principal debate is not only whether Japanese authorities will deliver but rather whether it will be effective. Recent interventions by the Swiss National Bank have on balance proven relatively incapable of stopping the appreciation of the CHF. In theory, FX interventions can operate through three different channels: The signalling channel where the intervention signals a future path of monetary policy; the portfolio balance channel where changes in the supply of imperfectly substitutable assets affect their relative prices; and the coordination channel where the Central bank intervention is seen as a way to encourage market participants in supporting a return to equilibrium.
The Federal Reserve Bank of San Francisco has a very good and simple (although dated 2003) update on the theoretical and empirical measures for FX intervention effectiveness. The event methodology that they use suggests that the interventions are effective over a short period of time (i.e. no more than a month). The methodology does not shed light however on the transmission channels at play. Rasmus Fatum from the Dallas Fed suggests that despite conventional wisdom and previous academic work, the portfolio balance transmission channel can produce successful results to fully sterilized FX intervention. Information or awareness about intervention which could signal a future path for monetary policy is however proven to be ineffective in a world where policy rate is already at 0. The Reserve Bank of Australia has proposed in accordance with Friedman (1953) the profitability test as a good measure of whether interventions are effective as stabilising the exchange rate and limiting excessive moves. Chris Becker and Michael Sinclair have indeed showed that since the AUD floated, its interventions were effective against that measure.
Lex in the Financial Times argues that with official disapproval for FX intervention by the G7 since 2007 and general disliking by the G20 for exchange rates set by anything else than market forces, verbal interventions have become far less effective as they are far less credible.
China’s yen for yen
Michael Schuman writes in the Curious Capitalist blog that China has bought a record amount of yen assets this year according to recent data published by the Japanese MoF. What does that mean? China is very likely attempting to further diversity ifs currency holdings, especially due to the rough ride the euro has had this year amid the region's debt crisis. But more importantly, China's new yen for yen is having a big impact on the Japanese economy. China's moves on the yen aren't big enough to have a major impact on its value – but fund managers have begun to follow China's lead on currency strategy, and could well be following Beijing in building up holdings of yen as a result. That clearly shows the kind of influence Beijing is having on world currencies these days. To a certain extent, Beijing can play a key role in deciding what happens to the world's major currencies.
The FT Money Supply notes that the latest US efforts to urge China to let its currency appreciate faster could further deter Japan from official intervention on the yen. The diplomatic drive to get Beijing to ease off selling renminbi could become a harder sell if a prominent G20 member - indeed, a G7 member - is intervening as well.
Tim Duy argues that the USD, the Renminbi and the Yen are on a crash course. Using Japanese MoF data, he shows how the PBoC has increased its Yen purchases massively this year (5 times what it bought over the last 5 years combined) in a move that appears to be a mix of beggar thy neighbour policy and outsourcing USD purchases if the BoJ is forced to intervene to quell the appreciation of the JPY. This diversifies the PBoC, limits frictions with the US Government and improves China competitiveness in Asia.
Why don’t Japanese firms invoice their exports in yen?
Takatoshi Ito and al. note that whenever the yen appreciates substantially, Japanese exporters scream and the government becomes under pressure to do something. This has been the story many times in the past, and the story is repeating itself now. That raises the question: Why don’t Japanese firms invoice their exports in yen to avoid sudden losses of profits? Japanese exporters have a strong tendency to choose the importer’s currency for their exports to advanced countries such as the US and EU. Second, dollar invoicing is prevalent in Japan’s exports to Asia. According to the authors, Japanese exporters' invoicing behaviour is closely related to active overseas operations of Japanese manufacturing firms and, among others, growing intra-firm trade. Even though a large part of Japanese firms’ cross-border production network is built in Asia, the final destination market for Asian subsidiaries’ exports is often the US, where dollar invoicing is prevalent.
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