Japanese Central Bank- Throwing good money after bad

Posted on November 11, 2011

The Japanese Yen is the flavor of the day, the week, the month and the year. Whenever there is even a hint of economic and/or political commotion, the Yen is the sought out asset by international investors and speculators.  It is an interesting phenomenon, considering that Japan’s budget deficit is almost twice the size of their GDP. However, there is a major difference between Japan’s debt and the U.S. deficit or the European Sovereign Debt debacle. Japan’s exposure is all domestic. They have no exposures to international creditors.

For years Japan has been able to pay domestic creditors with proceeds generated from huge international trade surpluses. The paradox, though, is that the stronger the yen become, the larger the negative  it has had on Japan’s trading efforts.  Japan has fallen from the second largest economy in the world, behind the U.S. and China to number three.  The prolonged escalation of the Japanese Yen has had a continuing diminishing impact on Japan’s trade surplus. Their industrial output has fallen, retail sales are down, and export growth is slowing considerably.
Japanese exporters have been exerting immense pressure on the Central Bank (CB) to intervene in the foreign exchange markets to force the value of the yen lower, even if the central bank has to take action unilaterally.  This year Japanese exporters have indicated to the government that they could remain profitable, if the value of the yen was at 86.30 or weaker.  So you can imagine the compelling demands they are putting on the government with the yen trading at 77.

In most instances, when a CB intervenes without the support of other major central banks, the success of imposing and maintaining a specific rate or range for a currency in a 4 trillion dollar a day liquid market is not simply an uphill battle, but a major war.  Nevertheless, when the Japanese Yen hit record highs in August, the CB intervened by itself, selling yen and purchasing over 58 billion dollars of foreign currencies.  The result of the lower valued yen however, was costly and short lived.

With the persistent turmoil and uncertainty in the eurozone, capital flows to Japan continue to boost the worth of the yen. On October 31st when the Yen hit another post WWII record high of 75.35, the central bank, unaccompanied by any international assistance, intervened in the currency markets selling an estimated 100 billion dollars worth of yen. Still, this staggering sum had only a brief influence on the rate of the yen. Due to the currency interventions of the Central Bank, Japan now holds foreign exchange assets that have lost a half trillion dollars in value.

The foreign exchange markets anticipate additional interventions by the Japanese CB.  This will give investors and speculators another opportunity to buy the yen at a lower cost.  However when the central bank halts their sale of yen for foreign currencies, the value of the yen will increase – because the underlying problems of the European Sovereign Debt and banking crisis remain unresolved and in disarray.

Isn’t it ironic that a weaker yen initially allowed Japan to develop into an exporting Goliath producing massive trade surpluses which ultimately turned the yen into the currency of choice. This may eventually impact Japan’s capability to accumulate considerable surpluses, and thus expose the yen to market induced weakness.

In the meantime, it appears that the Central Bank of Japan is throwing good money after bad.

For questions /information, contact Joel Borshof


Posted in: Uncategorized