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Will G-7 intervention work?
Yesterday, the G-7 group of major industrial countries announced plans for coordinated intervention in the foreign exchange markets in order to halt the rise of the yen against the currencies of other developed nations. In the wake of last week’s earthquake and tsunamis, the yen had risen by about 5% against the dollar. Will the G-7 be successful?
The short answer is “…most likely, no.”
The main reason is that the major international commercial banks, who are the main forces in the global currency markets, are far larger and have greater financial resources than national governments do. That might not have been true twenty-five or thirty years ago, but it is today. Even the G-7 nations acting together don’t have the financial firepower to oppose a concerted move by the banks. In the past, it hasn’t helped either that governments have typically tried to defend currency values that were politically attractive but economically unsound.
Japan the most skillful government player
I’ve been watching the currency markets as a global investor for over twenty-five years. Over that time, the country that, to my mind, has the best record in influencing the direction of its currency is the Japan. Understanding it can’t oppose the banks directly, it has waited until a wave of speculation has almost exhausted itself and then applied enough pressure to send the yen in the opposite direction.
Japan’s present stance is a curious one, though. The current administration in Tokyo, the Democratic Party of Japan, came into office with the intention of reversing the long-standing (and very outdated) policy of the Liberal Democratic Party of always aiming to weaken the yen in order to help the prospects of export-oriented industries. Nevertheless, when the original DPJ finance minister tried to enforce the new policy, he was replaced with someone more willing to cater to the Keidanren. The new minister immediately began selling the yen in what I saw as simply a wasteful attempt to establish his pro-industry bona fides. That was Naoto Kan, who is now the prime minister. Who knows what he’ll do now.
A second curious aspect of the situation today is that there’s no good reason for the yen to be a strong currency. The country’s workforce is shrinking. The government is ineffective and heavily in debt. The budget is in deficit. And the country hasn’t shown any real growth in over twenty years. Japan’s most “positive” feature vs. the euro or the dollar is that it’s a known quantity and has less near-term potential for negative economic developments than the EU or the US.
Why has the yen been rising, then? After the Kobe earthquake in 1995, Japan repatriated large amounts of money invested abroad. Insurance companies needed funds to pay claims. Parties–individual or corporate–who had no third-party insurance needed money to rebuild. this activity drove the yen up by about 20% against the dollar in the months following the earthquake. It’s probably too soon for this to be happening again. The yen probably started to rise early this week as speculators began to bet the same thing would happen again.
Interestingly, the yen gave back almost all its gains as soon as the G-7 announced its plans and Tokyo was seen selling the yen aggressively in the currency markets. To me, this suggests that the big players in the market haven’t decided what to do yet. In the end, though, it will be the banks, not the G-7, that decide whether the yen strengthens or not.
What’s the significance of a rise in the yen for investors?
An appreciating currency has two effects:
–it slows economic growth in local currency terms, and
–it reorients what economic energy there is–away from export-oriented industries, and toward domestic-oriented firms and importers.
If you were investing in Japan and thought the yen would rise, you would overweight domestic firms and underweight exporters and other companies with large foreign-currency exposure. But the most sensible thing for most people to do, as I suggested a couple of days ago, is just to stay away. (I own two social networking stocks in Japan, DeNA and its smaller competitor, Gree. For now, I’m keeping them both. These are youth-culture special situation stocks that are growing very fast, so I think they’ll be relatively unaffected by problems in the overall economy. But I wouldn’t advise anyone to follow my lead.)