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Yen lessons from a hotel suite
Picture the scene. A darkened room, minders huddled by the trouser-press, two men talking in hushed tones - perhaps over a drink from the minibar. It is neutral ground. But it is not a rendezvous between Moscow mobsters. The location is Tokyo. As the yen soared close to ¥103 against the dollar this week, Kiichi Miyazawa, the Japanese finance minister, and Masaru Hayami, governor of the Bank of Japan, called a meeting. In a hotel room. Neither wanted to go to the other's office. It must have been an interesting chat. Fiscal pump-priming has done what Japanese consumer demand could not: a recovery is under way. The economy expanded 1.1 per cent in the year to June. The stock market is up 25 per cent this year. Foreign investors have piled in. And the yen has risen. Those who placed their faith in a recovery play, and in current account fundamentals, have made a killing. The yen was at ¥120 three months ago, and at ¥135 this time last year: ¥103 is the highest level since early 1996. A weaker dollar/stronger yen is exactly what the Japanese government does not want. The finance ministry is desperately worried that an overvalued yen could choke-off the fragile recovery. As the yen soared this week, the stock market sold off. It is not all a story of yen strength. This week's US current account figures prompted a dollar slide. The deficit was a record high of $81bn in the second quarter, an 18 per cent increase on a deficit of $69bn in the first three months of the year. Consumers are spending like there is no tomorrow. Their savings rate is negative. There is no sign of the spending spree slowing. Retail sales rose 1.2 per cent in August, up 10.6 per cent year-on-year. The US Federal Reserve, which raised interest rates by a cautious quarter point in July, and again in August, is going to have to keep raising rates if domestic demand continues to outpace the economy's growth rate. Despite the prospect of higher interest rates, worries about the gaping US current account deficit seems to be what is moving the market. Money supply Back to the hotel room. Worried about a too-strong yen, the Japanese finance minister can tell the central bank to intervene in the foreign exchange market. But the BoJ is jealous of its control over the money supply. Throughout the year, when it has been told to intervene the BoJ has followed instructions, creating yen to buy dollars. It has then immediately taken the extra yen back through the money market, with no net change in the money supply. Economic theory says that "sterilised" intervention should have no effect. Japan has provided the evidence. Joint intervention On his way out of the hotel, Mr Hayami made clear that he had not budged an inch. With the BoJ refusing to play ball, the government has set its sight on joint intervention with the US, and on next weekend's meeting of G7 finance ministers and central bankers in Washington. On Friday, rumours of a deal in the making brought the yen back below 106 (a significant fall, but still too high for Japan's comfort). Past experience suggests that the US may do a little to help - perhaps Europe too. But not very much. Investors may feel a sense of déjà vu. The yen has been repeatedly overvalued over the last 20 years. Investors have experienced a great deal of volatility. Japan has a structural trade surplus, and a structural excess of domestic savings over investment. The goods have to go somewhere (a lot of them go to the US). The money generated has to go somewhere too. The exchange rate does not just move in response to the trade account and interest rate differentials. It is also driven by capital flows. The trade surplus sucks in dollars. Japanese investors either buy assets abroad or the exchange rate rises sharply - as has been happening. At the moment, US assets look overvalued to Japanese investors, and the current account deficit makes the dollar look vulnerable. Some investors are biding their time, keeping their money at home. If everyone waits for a dollar fall/yen rise, it can be self-fulfilling. A short, sharp bout of joint intervention with the US might break the bandwagon effect. But the strong yen is largely a Japanese problem for the moment. A really big dollar slide, or a Japanese collapse, would change attitudes in Washington. But the US does not have much in the way of foreign reserves to play with. This means that the BoJ may well be forced to swallow its pride, and increase the money supply, to stop the yen strangling growth. From a policy perspective, this is the right thing to do. Combined with an inflation target, to cap inflationary expectations as well as counter deflationary ones, that would also be good for Japanese equities. |
