|Name / Sign / Code||Japanese Yen / ¥ / JPY|
|3 / 165|
|Central Bank||Bank of Japan
|Interest Rate||0.0% (July, 2012)|
|Inflation Rate||-0.40% (July,2012)|
|Printer||National Printing Bureau
|Correlated Class||Nikkei 225|
The official currency of Japan, the Japanese yen (sign:¥; code: JPY) is the third most traded currency after the US Dollar and Euro, accounding for 19% of the daily global trading. USDJPY is the second most active pair after the EURUSD, accounting for 17 percent of the daily global trade volume, according to the 2010 BIS survey, while the EURJPY is the most popular of the Yen crosses.The Japanese Yen is also widely used as a reserve currency after the US Dollar, Euro, and British Pound.
|1||US Dollar||USD ($)||84.9%|
|3||Japanese Yen||JPY (¥)||19.0%|
|4||Pound Sterling||GBP (£)||12.9%|
|5||Australian Dollar||AUD ($)||7.6%|
|6||Swiss Franc||CHF (Fr)||6.4%|
Currency Reserve Status: The Yen only represents 4.1% of the world’s currency reserve, on par with the 4.1% held in Pound, both of which fall in third place after the 62% held in US Dollar, and 24% held in Euros. See global currency reserve table.
However, Japan holds large foreign currency reserves of $1.27 trillionsecond to China’s $3.3 trillion), which boosts the value of the Yen. List of countries by foreign exchange reserves: here.
In most broad currency baskets, JPY has a high weighting.
|Basket Index / Currency||Weighting|
|USD Dollar Index||EUR (57.6%),JPY (13.6%) , GBP (11.9%), CAD (9.1%), SEK (4.2%), CHF (3.6%)|
|IMF Special Drawing Rights (SDR)||USD (41.9%),EUR (37.4%), GBP (11.3%), JPY (9.4%)|
In terms of pair popularity, USD/JPY is the second most active pair, accounting for 17% of the daily global trade volume, according to the 2010 BIS survey.
Central Bank: Bank of Japan (BOJ)
|Headquarters||Chuo, Tokyo, Japan|
|Mandate||Maintain Price and Financial System Stability|
|BOJ Governer||Masaaki Shirakawa|
Established in 1882, the Bank of Japan (BOJ) is one of the most important central banks in the world due to its long-time role as the source of the cheapest funding, with its 20+ years of near-zero interest rates fueling the carry trade in international finance. Though it is ostensibly independent from government, it is hardly an independent central bank in the manner of Western central banks: it does elect its own chief (unlike the situation in the U.S. and the E.U.), but the government’s wishes and expectations play an important role in deciding who is the eventual winner in the process. In addition, the regular operations of the bank are also run in close cooperation with the government, and the Bank of Japan Act requires it to act in harmony towards the goal of realizing national goals.
Mission and Practice
Following the bursting of Japanese Asset Bubble of 1990, the BOJ has maintained a zero interest rate policy to prevent even deeper deflation and possible economic contraction in Japan. This is an ongoing major intervention and has produced dubious results. Apart from the low rates, the BOJ has been known to have major interventionist strategies to deliberately weaken the Yen. Although both the Bank of Japan Act, and the Bank’s official statements claim that the Bank of Japan is focused on price stability as its main objective, in its actions it has been more keen to try to weaken the currency to defend its export sector. The BOJ has periodically intervened in the currency markets to print Yen and buy US Dollars to weaken the Yen. But lately the greatest force of currency weakening has been its printing money to buy government bonds to shore up one of the largest budget deficits in the world. Tokyo policy makers have the dubious luxury (which Greek, Italian and Spanish counterparts lack) of being able to print money to keep the government from defaulting (called debt monetization ). When the budget deficit continues to expand, and the people’s savings continue to diminish, the BOJ is left to the job of printing money to buy more bonds as part of their asset-buying program. The BOJ’s government-bond purchases mirror similar actions by other leading central banks around the world, but the BOJ stands out in part because it is increasing its purchase amount aggressively because the deficit, and total debt size, is much greater as a percent of GDP (government borrowing is close to 220% of GDP).
- Japan is the third largest national economy, after the US and China. For such small country, it has a sizable GDP of 5.8 trillion dollars, with a per capital GDP (PPP) of $34,000 (2011, est), 25th highest in the world.
- Japan remains a heavily export-oriented economy. It is one of the largest exporters in the world, with close to $788 Billion in export volume in 2011. Its main trading partners are China and the USA, followed by South Korea, Taiwan, Hong Kong, Singapore, Thailand and Germany. Its main export goods are cars, electronic devices and computers. Think Toyota, Mitsubishi, Canon, Sony, Toshiba, Hitachi. The export sector has helped the Yen by maintaining a high demand for it.
- As a result of the collapse of a gigantic asset bubble in 1990, corporations went into debt minimization mode for the last two decades, which has contributed to Japan having one of the lowest inflation rates in the world. While the Keynesian camp outside of Japan (in academia and media) have loudly advocated inflationary strategies (read: more QE/money printing) to solve Japan’s “deflationary depression”, the Japanese people have seen a lot of good come from mild deflation: better use of savings, more affordable prices, higher standard of living, cheaper products for export and increased demand for yen.
- The Japanese government (heavily influenced by Keynes) lowered and kept interest rates near zero for the last two decades to spur more borrowing and spending (which they think is the lifeblood of the economy), and when its people did not take the bait and instead continued to pay down debts, they declared this is a sin (paradox of thrift), and proceeded to borrow and spend for the “good of the people”, creating the massive public debt monster Japan has today (225% of GDP). Despite a public debt much larger than Greece, this debt monster has not taken center stage for a number of factors, the biggest being that its good citizens have been rolling their excess savings into the government bonds (taking 90% ownership), in stark contrast to the high foreign exposure of European sovereign debt.
- Record low interest rates did not tempt the Japanese people to recklessly borrow and speculate on asset bubbles (stocks and houses) that we have now seen pop almost everywhere else in the developed world. That is a good thing. Inflation adjusted real estate prices in Japan seemed to slowly descend in value over the last two decades in search for a floor after the burst bubble in 1990, whereas everywhere else the real estate and credit bubble has become the main driver of the economy. When the global asset bubbles began to pop in 2008, Japan had nothing to pop and became a safe haven for that reason. Most of the developed world remains underwater in debt. Japanese citizens have assets of JPY 1,471 trillion or nearly $19 trillion, yet consumer credit amounts to a mere 2% of their assets.
- Record low interest rates were taken up by global speculators in the 2000s: they borrowed $1.2 trillion worth of low-cost Yen (with near zero interest rates) in order to buy higher yielding currencies, stocks, and commodities abroad in what became known as the “Yen Carry Trade”. This accelerating the growth of asset bubbles abroad. It also helped keep the value of the Yen low compared to other currencies, which helped out the export sector of the economy. This highly leveraged carry trade became sour, and eventually unwound when the US dollar began to fall vs the Yen. When the carry traders all rushed for the exits at the same time in the late 2000s, the herd effect created an avalanche of panic sales on global stock markets. The unwinding of all these Yen carry trades lifted the Japanese currency to multi-years highs by the end of 2008.
- As of 2010, Japan’s labor force consisted of about 65.9 million workers. Japan has a low unemployment rate of around 4%, which is outstanding given that US, UK and Europe have over 10%.
As of July, 2012:
From 2008 to 2012, the Yen been trending stronger against most of its major pairings — USD, EUR, GBP, CHF, CAD, AUD–as you can see from the chart below:
Incredible as it seems, the Yen has outperformed all its major competitors by a staggering 20-80% from 2008-2012. It handily beat the Pound by 76.67%, the Euro by 62.09%, and the US and Canadian Dollars by 43%. These currencies fell hard against the Yen because their respective economies and currencies had become bursting bubbles while Japan was sitting at the bottom of its own, 20+year post-asset bubble.
Actually, Japan sat at the epicenter of “bubble-mania” in foreign exchange because its yield starved domestic investors had plowed $6 trillion of their savings into overseas assets by 2007, making Japan the world’s largest creditor nation in the world. In addition, global speculators borrowed $1.2 trillion worth of low-cost Japanese Yen (with near zero interest rates), in order to buy higher yielding currencies, commodities, and stocks held abroad in what became called the “Yen carry” trade. The “Yen carry” trade proved profitable while the US Dollar and other big currencies were climbing higher against the Japanese note, but this highly leveraged carry trade became sour, and eventually unwound, when the US dollar began to fall vs the Yen. Carry traders quickly dumped their speculative positions in foreign stock markets when the Yen was climbing, in an effort to avoid bloody foreign currency losses. When the carry traders all rushed for the exits at the same time, the herd effect created an avalanche of panic sales on global stock markets. The unwinding of all these Yen carry trades lifted the Japanese currency to multi-years highs by the end of 2008. The Yen continued its strengthening trend since 2008 because the $6 trillion in Japanese savings had home come to roost, while billions more in foreign savings are being investing in the Yen as a safe haven currency that in the midst of a global recession, was seen to be more reliable than the uncertain US economy and inflationary US Dollar.
Factors Driving the Value of Yen
|Indicator||Trend Stats||Graph Relative to Majors|
|Real GDP Growth Rate||Sluggish
Global Post-Bubble (2008-2011)
higher than UK,
lower than others.
(as % of GDP)
-3X US, EU, UK, Canada, Australia
|Real Interest Rates||Steady
Global Post-Bubble (2008-2011)
Currently better than rest.
Source: World Bank
|Debt-GDP Ratio||Largest in World
220% of GDP
-2.8X EU,UK, and Canada
* 20+ years of Near Zero Interest Rates
* Occasionally selling trillions of Yen to buy billions of Dollars
* Steady increase in printing money to buy Assets such as Japanese Government Bonds (JGB).
Cycle (Housing & Stocks)
|Housing (Bottom): Prices
Fell 20% since 1980;
Prices fell 50% since 2000
Real GDP Growth
From 1990 to 2011, Japan has had a relatively sluggish annual growth of approximately 1.14%, as compared to United States (2.5%), United Kingdom (2.27%), and European Union (1.92%). In cumulative terms, the real GDP in Japan has risen 24% over the 21 year period, in contrast to 54% for US, 48% for UK, and 40% for EU.
However, it should be born in mind that Japan’s GDP growth has been slowed over this period because its corporations have been busy paying down debt – instead of borrowing and investing — as a result of the burst asset bubble of 1990. Moreover, it can be argued from asset row of the table above, that much of the growth in the US, UK and Europe has been artificial, in that it has been masked over by asset bubbles in the stock and housing markets. Japan achieved relatively steady growth without having any bubble growth in its stock or home prices. That is real growth.
Now that Japan’s corporations have paid off most of their debt as of 2005, it is a matter of time before they become less debt adverse and start to borrow and invest again. Japan’s economy had started to pick up in 2004 (2.54%), 2005(1.94%), 2006 (3.31%), and 2007 (3.189%), and it might have remained steady at 3% growth if had not been for the global financial crisis of 2008. It did not go into negative territory like other developed nations during the crisis year of 2008, but it did feel the pain of 2009 with all the others at -4.4%. The severe downturn was the result of slumping exports in consumer electronics and auto sales, 16% of Japan’s economy and a driving force behind the country’s economic revival from 2002-2008.
How did the Natural Disasters of March, 2011 Affect Japan and its currency?
As everyone remembers, Japan was hit with the double disaster of a 9.0 earthquake and resulting tsunami in March 2011 that tore through the country’s north-eastern coastal communities and killed almost 16,000 people (plus 3000 missing), injuring more than 6000, and destroyed the lives of thousands more (330,000 living in temporary housing more than a year after the event). This double disaster in turn triggered a third crisis at the Fukushima nuclear plant. The Cabinet Office of Japan estimated it cost the country 16.9 trillion yen in damage to buildings, infrastructure, and utilities, but the country’s national and local authorities believe the reconstruction will actually cost more than 23 trillion yen over a decade. That is a staggering cost. Yet economists are foolish enough to argue that Japan has a ripe chance at economic recovery because of this disaster, believing that natural disasters are stimulative to the economy. The truth is that floods, fires, hurricanes and earthquakes destroy wealth and diminish living standards. The idea that we can make use of new resources that we already had is a terrible idea. If disaster = growth, we could carpet bomb California. Interestingly enough, the currency strengthened as Japanese investors repatriated their currency from overseas investments to help with the recovery.
Luckily for Japan, it still has a positive current-account surplus (2.0% of GDP; 2012) while the U.S. and eurozone both have negative current-account deficits (US: -3.10% of GDP; Eurozone -0.4% of GDP; 2012). Historically, from 1980 until 2011, Japan’s Current Account to GDP averaged 2.59%, reaching an all time high of 4.80%in December of 2007 and a record low of -1.00% in December of 1980. It has been this strong current account hat has caused the Yen to gain 84% against most currencies from 1986 to 2011, including a 13% gain in 2010. The strong export sector has helped the Yen by maintaining a high demand for it.
The broadest measure of trade, the current account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid). Typically, the balance of trade is the most important part of the current account and thus the current account and trade balance often move in lockstep. But sometimes, as in the present case of Japan, it has enjoyed such an incredible run of trade surpluses from 1963 to 2011 that its private sector has been awash in savings that allowed it to invest in substantial overseas assets and investments, all of which creates a sizable rental income that bolsters the current account. That being said, the foreign-investment income has slacked off from its 2007 highs as a result of globally low interest rates and the global downturn.
The main component of the current account, the trade balance, has lately been dipping into deficit zone. In late 2008 and early 2009, Japan experienced two dips into trade deficit because of the rapid strengthening of the Yen as investors unwound the carry trade and flocked to the safe haven currency during the heart of the global financial crisis. This Yen strength made Japanese goods more expensive during a time when consumers hunkered down in their spending. More recently, in 2011, there as another dip into trade deficit because of the Tohoku earthquake and subsequent tsunami that turned Japan into a lager importer of materials and energy to rebuild the country and replace nuclear power plants that had shut down. The trade deficit has persisted through 2012 as the economic slowdowns in United States, Europe and China have caused its people to cut back on the spending of unnecessary consumer products made in Japan. It will be interesting to see if the trade balance continues to trend towards in the deficit zone, or it will emerge back in surplus.
Razor Tip: Traders should watch to see if the trade balance continues to trend into the negative and if the current account follows suit. The currency of the country with a trade surplus, and/or Current Account Surplus, is usually more attractive than one without. If Japan’s trade balance continues to trend into the negative, and its current account follows suit, the Yen will weaken.
Continuing factors that may continue to weaken trade balance and current account:
- Prolonged recession in United States and Europe, which continues to weaken demand for Japanese exports
- Strong yen making Japanese goods more costly
- Strong yen and high corporate taxes encouraging more manufacturers to shift more of their production abroad, which in turn curbs exports.
- Aging population forced to reduce the savings rate even further; if private savings shrinks and government borrows heavily, Japan will inevitably move into current-account deficit and become a net importer of capital.
Interest and Inflation
For the last two decades (since the pop of the 1990 asset bubble), the Bank of Japan (BOJ) has lowered interest rates to near zero in fruitless attempt to get consumers and corporations to borrow and spend. They have not taken the bait. They remembered how borrowing and spending led to the asset bubble in the first place. They did not want to repeat their mistakes and instead rationally decided to pay down debt and save.
Inflation is the result of rising prices in an economy over time and is usually measured via a basket of goods called the Consumer Price Index (CPI). Because of the collapse of the asst bubble in 1990, Japan has had one of the lowest inflation rates since 1990. In fact, price levels decreased between 1998 and 2004, which meant that it went through deflationary phase. Today, Western academic economists talk of deflation as the bubonic plague and have insisted that more more printing is necessary to avoid a deflationary spiral. However, mild deflation that Japan has experienced can be very helpful. The low inflation rate has kept Japanese products cheap compared to products from other countries — making Japanese industries more competitive. This has added to Japan’s export growth and, in turn, increased demand for the Yen. Low inflation has also encouraged savings, a necessary ingredient to sound investing. Moreover, lower food and energy prices, more affordable health care and education, are good for all of us, and I’m sure the standard of living has improved for everyone in Japan because of mild deflation.
In a global world gone made with debt fueled spending, the greater evil for a currency trader should not be deflation but inflation. Though the ostensible mission of most central banks today is to provide price stability, most have utterly failed in their mission as their currencies have steadily depreciated over the last 100 years. The truth is that the Fed (and most central banks that mirror its example) exist for the sole purpose of providing the inflation (via money expansion) necessary to allow governments to spend more than it can collect in taxes. Which leads me to Japan’s monster sized government debt.
Japan has a monster sized public debt. The gross government debt/GDP ratio stands at 225%, more than twice that of United States, Europe and UK, and four times greater than Switzerland. There is no other developed country that has anywhere close to the magnitude of debt. Even Greece, the worst indebted country in Europe, stands at 165% debt to GDP.
How did it get so big? After the asset bubble burst in 1990, Japan took the Keynsian policy initiative to ramp up government spending to make up for the fall of aggregate corporate demand for credit. Corporations wanted to hunker down and pay down debt their debts, which Keynsians saw as rational on a individual basis, but deeply destructive on a collective basis. The called it the fallacy of composition, or Paradox of Thrift: if one spendthrift gets religion and starts saving, that is good, but if we all stop spending at the same time, it is bad because the economy needs the spending. They seem to think that if spending stops, the economy keeps on collapsing because it is not self-correcting and everything will get worse until the government steps in and starts spending on our behalf. Once this happens, the free fall stops, we all shake off our panic and start borrowing and spending again. For more than a decade corporations did not want to borrow and spend to the tune that was satisfactory for Japan’s Keynsian government, and so the government spent in borrowed and spent in their stead. Over two decades, Japan has borrowed staggering sums of money to fund domestic stimulus spending of questionable value, all of which has left this island nation with a ratio of debt to gross domestic product (GDP) nearing 225%, triple its size since 1992.
Paradoxically, while Japan has the worst debt among the major developed countries, its yield on Japanese government bonds (JGB) have been among the lowest and stable, even during the recent deterioration seen with the European debt crisis. Generally, Government debt as a percent of GDP is used by investors to measure a country’s ability to make future payments on its debt, thus affecting the country borrowing costs and government bond yields. If the debt is so huge, what explains this paradox of low yield.
Japan has been able to sustain this debt that would have crushed other economies long ago because of five factors:
- Stable domestic savings: the population saves an extraordinary percentage of its income and then invests those savings in its own government debt. More than 88% of Japan’s government bonds are owned by its people, who earn a measly 1% interest;
- Healthy current account status, which allows trading profits to roll into government bonds.
- If the people cannot fund all the deficit in a given year, then the Bank of Japan (BOJ) comes up to the plate to print money to buy the government bonds;
- It has healthy Total Reserves that are 40% of GDP, as compared to below 2.5% for Greece, U.S, Ireland, Portugal, Spain, Luxemburg and EU region at its entirety (which gives it cushion against shock); and
- It has the lowest concentration of foreign source funding (see chart below), while most of Europe has high exposure towards foreign funding.
However, as Japan’s population ages and retires, the nation’s savings rate will fall, and this might impact how Japan’s growing debt is going to be funded in the future.
Central Bank Intervention
Since the burst asset bubble of 1990, the Bank of Japan (BOJ) has kept interest rates at near zero for two decades with little “stimulative” effect. Its corporations did not take the bait and borrow as much as the bank would have liked, but its Government borrowed and spent in a very big way, creating the monster debt Japan has today. Eventually more money printing will be needed to monetize the debt, which will cause inflation to creep back into the picture, and only then will the BOJ be forced to increase interest rates.
Unintended Consequence (Carry Trade): Low interest rates since the mid 1990s combined with a ready liquidity for the Yen prompted investors to borrow money in Japan and invest it in other countries (a practice known as carry trade). This lead to accelerating the asset bubbles abroad. Also, for a few years in the 2000s, this carry trade helped keep the value of the Yen low compared to other currencies, which helped out the export sector o the economy. When the carry trade unwound in 2008, and money fled back into the Yen, exports became more expensive and the trade balance dipped into deficits.
Since Japan is a heavily export-oriented economy, Japanese officials are not afraid to get involved in the market to keep the JPY from strengthening beyond desired levels. A weak currency makes a nation’s exports cheaper to foreigners and creates a competitive advantage to gain market share. Japanese leaders have long feared that a strengthening of the yen against the dollar would reduce the country’s exports and increase its imports, which would reduce its GDP, slowing its economic recovery.
The government’s constant fear is that GDP growth will slow to a crawl and its trade balance will slip into a trade deficit. For the longest time it was thought that only so long as the Yen trades above 90, can it be competitive in the global stage. Now the Yen trades in the low 80s, high 70s, raising huge concerns.
In the past, and off and on, the Bank of Japan will try to intervene in the currency markets to print Yen and buy dollars in order to weaken the Yen. This type of intervention comes in two flavors: sterilized and unsterilized.
a) Sterilized Intervention
This is the buying of dollars offset by domestic selling of yen denominated bonds to keep Japan’s money supply unchanged. However, the 2003-2004 sterilized intervention did not stop the strengthening Yen against the dollar: Bank of Japan sold 20.2 trillion yen ($177 billion) in exchange for dollars, then sold another 14.8 trillion yen ($139 billion), but
the Yen still appreciated more than 14 percent during these 15 months, moving from 119 to 104 yen per dollar.
b) Unsterilized Intervention
Printing Yen, then Selling Yen to Buy dollars. If the intervention is simply printing Yen to buy dollars, then the currency intervention solution should be twice as powerful, because it is acts to weaken the Yen when trillions are sold to buy dollars, as well as weakening the Yen because of the money printing itself, which is inflationary. However, it embarked on this new, more promising sterilized intervention in 2010 without much success. The BOJ sold 2 trillion yen ($24.6 billion) to buy dollars, but the interventions were overwhelmed by private transactions, leaving the underlying market trends unchanged.
BOJ Balance Sheet and Money Printing:
The government decided to step and borrow and spend to every greater degrees in Keynsian attempt to soften the bubble fall and revive the economy, but that only pushed the debt into the public purse. Now it is a monster public debt. While the people have to some extent been able to channel their savings into this debt, there is still a deficit. The BOJ has taken it upon itself to print money to buy government bonds and shore up the deficit. You can see this in the red part of the BOJ’s Balance Sheet. When the budget deficit continues to expand, and the people’s savings continue to diminish, the BOJ will be the one struggling to print and buy more and more bonds. This will be the biggest factor of government intervention moving forward, so keep tabs on it.