Wednesday, September 15

Bank of Japan Intervention: What Happened Last Time? What's Next?

On Tuesday the yen traded at ¥82.88 yen per dollar, its highest level since May 1995. As predicted the Japanese government decided it had seen enough and instructed the Bank of Japan (BOJ) to 'intervene in the currency market' (aka print money). This caused the yen to quickly fall back to ¥85 per U.S. dollar level.

The BOJ also confirmed that its intervention -- reported to be in the ¥300-¥500 billion range ($3.61-$6.02 billion) -- will go unsterilized, which means that the BOJ will not seek to withdraw the new yen it has 'printed'.

Currency Traders Now Have an ¥82 Yen Bullseye

Via Bloomberg, Japan’s Chief Cabinet Secretary Yoshito Sengoku communicated two very important pieces of information:
  1. ¥82 yen per dollar is "the line of defense to prevent currency strength from harming the economy"
  2. "The government is seeking to gain the understanding of the U.S. and Europe for the intervention"
We now know the Japanese government's pain point (¥82 yen per dollar). Providing the market with an exact target -- not unprecedented for Japan (see below) -- could prove to be a mistake.

We can also infer from the "seeking to gain the understanding" comment that the BOJ's intervention was not only uncoordinated, but also without the consent of other central banks. It would be surprising if the Fed and ECB signed off on the BOJ's intervention. Europe, the U.S. and other nations are mired in a slow recovery and seeking export led growth. Japan's currency intervention makes U.S. and European goods more expensive in Japan.

What Happened Last Time the BOJ Intervened?

It was six years ago when the Bank of Japan last intervened in the currency market. In 15 months through March 2004, the BOJ sold ¥35 trillion yen ($421.7 billion) for dollars. What was the BOJ trying to accomplish? As noted back then Economy Trade and Industry Minister Takeo Hiranuma said "a dollar at ¥115.00 is the ultimate life-and-death line for Japanese exporters".

Two comments:
  1. Since then the yen has increased by 35% in value relative to the U.S. dollar and this hasn't let to the "death" of Japan's export economy
  2. Even after a year year+ long intervention effort the Bank of Japan ultimately failed to stem a substantial appreciation of the yen.
Yen bulls may take some comfort in this history. However, currency investors should also be aware that the Bank of Japan is generally considered to be a worthier opponent than other central banks which have recently failed to halt a rise in their currencies.

What Happens Next?

Currencies trade relative to each other, so any assessment of the Bank of Japan's intervention cannot be viewed in a vacuum.

Trade Sanctions

Because it appears BOJ intervention occurred without the support and/or approval of other central banks it's uncertain whether a) there will be a response by other governments and b) what form that response would take. While the Swiss National Bank may have another go, a widespread tit-for-tat currency intervention by central banks seems unlikely. However, trade sanctions may be an option, although not necessarily against Japan.

Prior to the BOJ intervention China had been driving up the value of the yen by purchasing Japanese government bonds. Some have commented on how this was a roundabout strategy by China to trigger more dollar purchases (by the Japanese through today's intervention), which strengthens the dollar and thereby keeps China's currency undervalued (the Chinese renminbi is effectively pegged to the dollar).

By having the Japanese do its dollar purchasing, China may be hoping to avoid being charged by Congress as a "currency manipulator" (which may be imminent). I've written previously about a possible U.S.: China economic war.

Bottom line: with mid-term elections right around the corner expect more trade sanction rhetoric, and probably action.

Reserve Currencies

Other big news on Tuesday was further speculation about imminent Fed quantitative easing (QE 2.0) to the tune of $1 trillion. News that the Fed may print another trillion dollars helped drive the yen's appreciation to ¥82.88 versus the dollar. The euro also rallied today, crossing the $1.30 level. QE 2.0 would put serious pressure on the value of the U.S. dollar.

But what about Europe and the euro? Earlier this month the ECB announced it will extend the deadline for offering banks unlimited one-week and one-month loans until at least Jan. 18, 2011. Given the ECB's lax monetary policy and the almost certain default by one or more European countries, the euro can hardly be considered a safe haven.

Bottom line: none of the world's three most important currencies -- the dollar, the euro, and the yen -- appear strong.

Precious Metals

Investors concerned about a worldwide race to the bottom where countries seek to facilitate export growth with a cheap currency may want to consider precious metals. Precious metals such as gold (which on Tuesday had its biggest one-day gain in four months, shooting up 2% to an all time high of $1,274.75) are traditionally considered a hedge against currency risk.

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