the rising yen

Since the beginning of April the Japanese yen has risen by about 11% against the dollar.  Over the same time period, the currencies of Europe have  either held even or fallen against the US currency.  So this is not primarily a dollar issue.

At first glance, there doesn’t seem to be much reason for the move.  The domestic Japanese economy is weak.  Export champions continue along their well-worn track of loss of market share to nimbler Korean or Chinese rivals.  Last year’s reform promises from the Democratic Party seem to have had no more permanence than the cherry blossoms of the spring (see my post on the resignation of prime minister Hatoyama for more details).  In fact, with Ozawa loyalist Naoto Kan as the new PM, the sitting government, to my eyes anyway, is looking more and more like a rerun of 1980s-style Liberal Democratic Party administration.

Tokyo is even talking about intervening in the currency markets to stop the yen’s rise.  The just released results of a poll by the BIS illustrates just how futile a notion this is.  The survey reveals that the world currency markets have growth by about a third over the past three years and amounts to $4 trillion worth of trades each day. The ten largest bank participants account for three-quarters of the business.  How can any government compete with this size–much less one so heavily in debt as Tokyo.

So the economy’s dysfunctional–with even modest deflation for the past twenty years.  Interest rates are as close to zero as you can get.  Ordinary citizens are nostalgic for the “golden” days of the early nineteenth century, when Japan was isolated from the rest of the world.  How is this a recipe for a rising currency?  After all, it wasn’t that long ago that these attributes were ones that motivated international speculators to short the yen, not buy it.

As the endaka economy began to crumble as the Bank of Japan raised rates to cool speculative fever, the country chose, for good or for ill, to maintain its traditional way of life rather than to face its economic problems and restructure.  Periodic political attempts to revisit that decision have all failed, the latest being the election of the Democrats last year.  If this analysis is correct, the outstanding characteristic of the Japanese economy is that things just aren’t going to get better any time soon.

Odd as it may seem, I think this is what is attracting currency investors to the yen.

Real short rates in the US are negative; real short rates in Japan, even at zero nominally, are positive because of the country’s chronic deflation.  The only way this difference can express itself is through mild appreciation of the yen against the dollar.

Also, economically the worst is past for the US.  At some point, the domestic economy will become strong enough that the Fed will change its current extraordinarily loose money stance.   Then bond prices will fall.  We don’t have that worry in Japan.

Why now?

What made the currency markets decide to play this idea starting in April?  Maybe it was political developments in Japan.  It certainly shouldn’t have been signs of a slowing economy in the US, since that diminishes the chances of rising rates.

Twenty-five years of watching currency markets as an international equity investor have taught me that the currency markets march to their own drummer and are almost always way ahead of everyone else.  This is a short way of saying I don’t know.

But the political events in Japan were highly predictable.  So I don’t think they can be the reason.  Arguably, then, currency traders may be saying that the recovery in the US may be stronger than domestic markets expect and that rising rates are a more serious concern than we now realize.  That would fly in the face of the consensus, however.  We’ll see.