When Will Japan Intervene?

[Cross-posted from Japan Economy Watch] 

Well my dear JEW readers, as the global dollar sell-off continues in full swing against all major currencies we are moving into a territory which I just a few days implied to be wholly theoretical. You see, while indeed the USD has been trading at all time lows against Sterling and the Euro (to name but a few) the recent day's fall against the Yen has been particularly drastic. In time of writing and as such in real time the Yen is trading at a whopping 110.7 per USD. Now if that does not mean anything to you then have a look at the graphs I field in my recent large analytical post. As we can see the USD/YEN pair has moved from a little over 120 in May 2007 to about 110 today. So what does this mean? Well if you have a close look at my note linked above I emphasise the probability that Japan might actually intervene to keep the Yen down as we move closer to a USD/YEN of 100. But is that really probable? This is of course a pretty important question in itself but the mere fact that this is now being considered is sure to bring all kinds of spectres to the forefront of Japanese policy makers' mind.

(quote Bloomberg, and here)

The yen may rise to 100 per dollar by the end of 2008 as credit-market losses prompt investors to pare purchases of higher-yielding assets with loans from Japan, Lehman Brothers Holdings Inc. and Deutsche Bank AG said.Slowing global growth will also cause traders to pare purchases of riskier securities in so-called carry trades, Jim McCormick, head of currency research in London at the fourth- largest U.S. securities firm, said in an interview in Tokyo. He predicts the yen will climb to 100 by the end of 2008. Deutsche Bank forecasts 97.5 per dollar within 12 months.

Japan's currency gained 5.8 percent against the dollar this year as global stocks fell and U.S. investment banks reported losses linked to defaults on loans to homeowners with poor credit histories. The dollar slumped to a record low against the euro today on speculation widening credit-market losses will prompt the Federal Reserve to cut its benchmark interest rate for a third time this year. ``In our view, the yen is certainly undervalued,'' said Koji Fukaya, senior currency strategist at Deutsche Securities, the Tokyo unit of Deutsche Bank, the world's largest currency trader. ``The tightening credit market will weigh on the yen carry trade.''

Now, let me first address this idea of Yen 'undervaluation' and note two important issues. Firstly, what does it actually mean that a currency is over- and/or undervalued? I mean, in the concrete calculations; do we then incorporate the complex and essentially unique nature of Japan's demographic situation? Secondly and perhaps most importantly, an appreciation of the currency is associated with two things (all things equal); deflation and reduced competitiveness relative to the external environment. At this point many would be at pains to point out the lag with which these effects occur and as regards to exports many would even argue that this is exactly what the world needs; i.e. that Japan does its part in re-balancing the books. Alas, this is also part of the whole point since is this really realistic?

Finally, let me address the formal question with which this entry started. When will Japan intervene, if at all? This is a tricky question to answer and much will depend on the degree and abruptness of the current slide in the USD/YEN. But I will say this. The risk that Japan is now moving into a period of subpar growth is very high and this is only going to exacerbate the potential downside as global liquidity move in expectations of re-balancing. What the actual number is here is anybody's guess and by all means it is not even sure that Japan will intervene but take note. If the slide is as violent as it appears now the USD/YEN will see 105 in a couple of weeks and this won't go down well with the current economic environment at the moment. Personally I don't think (and certainly don't hope) that it will come to this but we are moving closer to what, only a few days ago, seemed a mere academic discussion.

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