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Why is the Value of the Japanese Yen so Strong? Interest Rates and the Carry Trade

0 1223 Market Intelligence

Alex Carrick

Positions:
Alex Carrick is Chief Economist for CanaData, Reed Construction Data’s Canadian economic forecasting and statistical service.

Economists

Over the last six months, two national currencies have performed better than all of the others, the United States dollar and the Japanese yen. The strength in the U.S. dollar is fairly easy to explain by the flight to security. The credit crunch and fears about failures in the financial sector have caused private investors and even many governments to put their trust in U.S. Treasury Bills, thus boosting the value of the greenback. Buoyancy in the yen, however, is a more complex and interesting story.

Over the last six months, two national currencies have performed better than all of the others, the United States dollar and the Japanese yen. The strength in the U.S. dollar is fairly easy to explain by the “flight to security.” The credit crunch and fears about failures in the financial sector have caused private investors and even many governments to put their trust in U.S. Treasury Bills, thus boosting the value of the greenback.

Foreign Trade – Loonie versus Yen Similarities

Buoyancy in the yen, however, is a more complex and interesting story. Where it starts is with foreign trade. In this regard, there is a similarity between the yen and the Canadian dollar. The Canadian dollar, also known as the loonie, climbed to parity with the U.S. greenback in September 2007, largely on the basis of a strong merchandise trade surplus.

The trade surplus was achieved through exceptional raw-material export sales, to emerging nations and to the U.S., particularly of oil. In fact, the loonie has increasingly become known as a petro-currency, with the value of the loonie moving in tandem with global crude prices. The world economic slowdown began last summer, bringing falling commodity demand and prices, and the value of the loonie has dipped accordingly.

Japan/'s trade strength lies in manufactured goods rather than commodities, but the idea is the same. A large trade surplus due to export sales of cars, cameras and electronic devices has traditionally meant a high demand for yen by foreigners to pay for these products. However, this does not tell the whole story, since the yen is still strong even as Japan/'s trade surplus is unwinding as a result of weakening demand from around the world.

Much of the Answer lies in Interest Rates

The answer must be found elsewhere and it lies mainly in interest rates, but there are several ways in which they are having an effect. First, due to Japan/'s lost decade of the 90s, its low inflation rate (perpetually bordering on deflation) and the continual need for stimulus, Japan/'s central bank has kept interest rates very low for a long time.

The upshot has been a yen valued lower than it otherwise would have been because interest rates in Japan were below those in the rest of the industrialized world. Now that interest rates have fallen in the U.S., Europe and everywhere else, while remaining essentially flat in Japan (i.e., because they can/'t fall below zero percent), this is lending more support to the value of the yen.

The “Carry” Trade

Second, there is something called the “carry” trade. This occurs when investors move sums around between countries to take advantage of different returns on essentially the same investment product. In this case, investors have been borrowing yen from Japanese banks due to their low interest rates and placing the money in other-currency-denominated bonds, bills and notes of other countries to earn higher yields.

Again, the exchange of yen for other currencies, until recently, has exerted a downward drift on the value of the yen having little to do with the fundamentals of the Japanese economy. Now that interest rates are more on a par across all nations, this downward bias has been removed and the yen is bobbing ever higher.

Bringing the Yen Home

And there is a third factor. Japan has accumulated large volumes of foreign currency due to its usual trade surplus. That money has been re-invested back in the United States and elsewhere. At this time, as unemployment is rising and anxiety is growing about harder times to come, some of that money is being brought back home. This is another source of more demand for yen, adding another fillip of strength to its value.

All of these factors are combining to keep the yen high and manufacturers in Japan on edge about the loss of their price competitiveness in overseas markets.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News.

by Alex Carrick

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