Recent previous postings in this blog had looked at where investors move their money in the good times and the bad. The choice is not limited to just stocks and bonds but also to what currency to invest in. One currency more than all others has seen its fortunes dominated by the global flow of money, the Japanese yen, and has sometimes had to pay the price.
In economic text books back when Your Neighbourhood Economist was at university, currencies were determined based on trade flows. If a country exported more goods and services than it imported (a positive balance of trade), its currency would rise. The higher currency would mean that the price of exports increased and imports decreased so that the balance of trade would head back toward zero.
However, globalization has meant that the flow of goods between countries has been overwhelmed by a flood of cash and so it is this that dictates the value of a currency. Investors now move their money into countries that were growing and as a result had high interest rates. Cash inflows into a country would lift the currency and raise the value of any investments in that country giving investors a boost to their returns.
With money becoming increasingly easy to come by, investors came up with a new trick – borrow money in a country with a low interest rate and move it somewhere with a higher interest rate. This is what is known as the carry trade and is where the yen comes in.
The Japanese economy has been in the doldrums after the bursting of a massive investment bubble in the late 1980s. Its interest rates have been close to zero for a long time so investors could borrow in yen and invest in bonds in other countries with relatively low risk. The carry trade also resulted in the yen being weaker than it normally would have been, because investors would sell the yen that they had borrowed, despite a large balance of trade and other factors that should have been driving the yen higher.
The yen thus became a gauge of the world economy. As long as interest rates elsewhere remained high on the back of a buoyant global economy, the yen would stay weak. On the other hand, an economic downturn would lower interest rates globally and prompt investors to buy yen to repay their borrowing which caused the yen to rise. So there was a link established whereby the yen was the currency to hold if an investor was pessimistic about the global economy. That interest rates in Japan were close to zero didn’t matter as interest rates would be low everywhere during a global downturn. Thus, the yen became a safe haven where investors would park their money when the economy turned bad.
The result of this is that, despite the onset of a recession both globally and in Japan, the yen was rising. This was a major blow to Japanese manufacturers which export lots of TVs and cars and are the mainstay of the Japanese economy. Perhaps, most perversely of all, the tsunami that devastated the Japanese northeast prompted a further rise in the yen. This was because the havoc caused by the tsunami was seen as being bad for the global economy due to its effect on Japanese business in the region which supplied parts to many international firms.
The yen reached peak of above 120 yen to the US dollar in mid 2007 to almost 75 yen to the US dollar early in 2012. So a jump in the yen to near 85 yen to the US dollar in March sparked interest that the direction of the market was about to change. The upturn in the yen was triggered by an announcement of further easing by the central bank in Japan which comes at a time where other central banks are winding down their efforts to prop up their economies. But little respite is expected for the Japanese economy until the interest rates else where such as in the US rise further. For now, Japan looks stuck with a currency which is more of a weathervane for the global economy than a currency that reflects its domestic economic climate.