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Yuan Line in the Sand?

  • Written by Bill Hubard
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Bill Hubbard, economist and columnist.Nothing changes and then everything changes as we may have seen in recent weeks when the Bank of Japan intervened in the Foreign Exchange (FX) market for the first time in 6 years. They sold JPY to buy USD in massive size, reports say it was more than $20bn, in a move designed to weaken their currency.

USD/JPY had fallen below 83.00, something that had not happened since 1995 and the cross had fallen more than 12% since May Day.

“We will absolutely not permit precipitous moves in the yen,” said Prime Minister Naoto Kan by way of explanation for his decision. The intervention was, however, widely condemned as something that was outside the rules of the game as conceived, though not universally adhered to, by the G-20. The problem stems from the fact that Japan acted unilaterally.

The head of the International Monetary Fund Dominique Strauss-Kahn said in an FT report that: “There is clearly the idea beginning to circulate that currencies can be used as a policy weapon.

Translated into action, such an idea would represent a very serious risk to the global recovery…Any such approach would have a negative and very damaging longer-run impact.”

Other nations playing currency hard ball in recent weeks include Brazil, where it has been reported that the country’s finance minister, Guido Mantega, has been warning of a currency war in an effort to hold the real’s value down and to cash in on a hefty tax on foreign bond purchases.

On the meantime, Japan is back in the market and Kan says they are prepared to take further “resolute action” despite complaints from politicians in the US and Europe.

“This is a deeply disturbing development” said Sander Levin, chairman of the House Ways and Means Committee, in a statement he made at a hearing last week on China’s currency exchange rate policy. The development that so disturbed the Representative from Michigan was in this instance not something that China was doing, but rather he was reacting to the news of Japan’s currency intervention. Levin described Japan’s unilateral intervention as “predatory” and he wasn’t the only one who disagreed with their decision. EU chairman Jean-Claude Juncker ‘chimed in’ with his opinion on the intervention saying “unilateral actions are not the appropriate way to deal with global imbalances.”
Of course, both the EU and US are not any happier with the way China manipulates their currency, but what they may be missing is that neither is Japan, and that may be the real story behind the intervention strategy.

Japan does more trading with China than they do with the US. But USD/JPY is still a key FX rate for them because the Chinese yuan tracks the dollar. The Japanese are just as frustrated as is the US and Europe with the unjustifiably low value of the yuan and even more so recently because they think China is unfairly pushing their advantage.

“Japan has expressed concern about China’s recent sharp increase in purchases of JGBs in the latest of a series of sour notes in a traditionally tense bilateral relationship that both sides had worked hard to steady,” said the FT.

“China’s purchases of JGBs is an especially sensitive issue as it plays into anxieties in Japan about the strengthening JPY and its impact on the economy… “There is something unnatural about the fact that China can buy JGB while Japan cannot (buy Chinese bonds),” Yoshihiko Noda, the Japanese finance minister said.”

In the first 7 months of 2010 the Chinese are said to have bought $27.4 billion worth of JGBs and there is some thinking that this has been a factor in the run-up in the JPY. China may simply be interested in diversifying their FX reserves portfolio, but that is beside the point for Japan who saw their currency test a key level versus the CNY on the day of the finance minister’s comments and that may have been the actual trigger for their intervention a week later.

The Japanese seem serious about their intentions in the FX market, which may or may not have any bearing on their success. But it may be more important to keep an eye on the relationship of their currency and that of China, rather than monitor the currency that they actually used to intervene.

By Bill Hubard