Why is the Japanese Yen so strong? What is itsimplications for an export-driven economy like Japan? s1160231 Shuhei Yamashita
Summary1. Back Ground2. Abstract3. Yen and Dollar Historic Trends (1) - (2)4. Expected the opposite5. Current Theory6. Japans Trade and Investment Cash Flow7. Demand for Japanese Assets
1. Back GroundWhy the Japanese Yen is so strong against the U.S Dollar now? ThYen reached recently a 15-year high against the Dollar. Wasthis in line with expectations? What is happening and what iscausing this? Here is our research and our conclusions on whythe Yen is so strong.
2. AbstractThe cause for the strengthening of the Yen is that the Yen is acurrency with net inflows; more Yen are bought then thatthere are Yen sold.The reason for this is the combination of the strengtheningtrend itself, the Japanese trade surplus, the low return oninvestments in the rest of the world, the expected monetarypolicy in the U.S. and the diversification of foreign reserves inother countries away from the U.S. Dollar and Euro. In anhistoric perspective, the strengthening of the Yen is nothingnew and not unexpected.
3. Yen and Dollar Historic Trends (1)The over trend during the last 20 years in clear, the Yen isgetting stronger against the Dollar.The Yen and Dollar exchange rate has a fluctuating patternwith continuous lower tops; the current strengthening of theYen since the last top in the chart is already taking placesince mid 2007.
3. Yen and Dollar Historic Trends (2) Thus a strengthening of the Yen is something that fits wellwith the historic perspective of both the last 20 years as wellas the last 3 years. Thus, there are no big surprises here whenthe Yen is continuing at this moment this trend. The unusual period in the last 20 years was in the 1993 – 1996period. The Yen was then relatively very very strong. I aminterested to hear explanations that cover that period.
4. Expected the oppositeThe domestic interest rates in Japan are about the lowest inthe world and not very attractive to park your money. Japan has an aging population and this will temper theeconomic growth in Japan compared to the more vibrantdemographics in the U.S. for example.Japanese public debt as a percentage of GDP is about twicethe size of the U.S. public debt. And the Japanese deficitdoes not look much better.
5. Current Theory1. The trade cash flow.- Exports from Japan cause demand for Yen to buy theJapanese goods.- Imports into Japan create supply of Yen to buy othercurrencies to pay for the imports.2. The investment cash flow.- Investments from outside Japan in Japanese assets causedemand for the Yen. If these assets are more in demand, theprice goes up and the Yen becomes even stronger. - Investments from Japanese investors outside Japan createsupply and thus a weakening factor for the Yen. When there isless demand for these assets the price in Yen goes down andthe Yen would strengthen.
6. Japans Trade and Investment Cash FlowTrade Cash Flow- Japan has a trade surplus and is exporting more thanimporting. This keeps the currency strong.- The strengthening currency could lower exports and increaseimports in the long run. But in the short term it reinforcesitself for example by reducing the supply of Yen required forimports. - Note that the U.S. is importing more than that it isexporting; remember the U.S. trade deficit? This weakens theU.S. currency.
6. Japans Trade and Investment Cash FlowInvestment Cash Flow- There seems to be a strong demand from non-Japaneseinvestors for Japanese assets, especially short-term moneymarket instruments. - The demand for assets outside Japan has definitely notbeen very strong recently; just think about how the stockmarkets around the world have behaved the last six months.
7. Demand for Japanese Assets- Partly this could come from foreign reserves diversification.Think about China for example who wants to be lessdependent on the U.S. Dollar or Euro. - Other investors are seeking a temporary parking place fortheir money when they sell their other assets. With the poorperformance of stock markets around the world, the very lowinterest rate on U.S. treasury and the strengthening trend inYen, Yen money market instruments could look veryattractive.
7. Demand for Japanese Assets- There could also be a perception among market playersthat the U.S. Federal Reserve may be more willing to conductaggressive monetary easing than the Bank of Japan. Theexpectation that more new U.S. Dollars will be printed thanthat there will be new Yen printed, will strengthen the Yen. - The expectation for the differences in interest rate inJapan and the U.S. will also have its influence on theexchange rate. The Japanese interest rates have always beenthe lowest. But when the expectation is that this differenceis will become less bigor when the U.S. is not expected toincrease interest rates for the foreseeable future, the carrytrade will slow down or unwind, strengthening the Yenfurther.