Yen Rally Continues to Defy Conventional Wisdom

Includes: FXY, JYN
by: Harry Tuttle

The rally in the Japanese Yen in the aftermath of the earthquake continues to defy conventional wisdom. Most people would expect the local currency to weaken for reasons that are as numerous as irrelevant since, one more time, the Yen is doing the opposite of what economic theory would predict. More interesting, however, are the explanations offered by our own American market pundits.

1) "The repatriation hypothesis"

According to this story line, the Japanese will finance the reconstruction of their country by selling assets abroad. Variations to this theme include: (a) the insurance companies, (b) Mrs. Watanabe, (c) everyone. The proof? This is what happened after the earthquake in 1995.

I could bore you with an analysis attempting to show that (a) is probably not true, or that nobody has any idea about (b) (although I doubt Mrs. Watanabe's speculative non-Yen denominated holdings are large if she lives anywhere near Sendai), but instead, lazy as I am, I decided to include a chart of USDJPY.

click to enlarge

JPY USD 1987 - 1995

As far as I can see, the repatriation either did not happen or did not make any difference. The Yen went right back to its previous level. Furthermore, as you can see in the next chart, it went much higher during the reconstruction period. The italics acknowledge lack of proof of cause and effect on my part; the move could be totally unrelated.

2) The "Soros vs. BoE Story"

This story line says that central banks are powerless to affect currency values when the market wants to push the other way. "That is what happened when Soros defeated the Bank of England."

Forgive me for questioning the common wisdom. As I recall, Soros was short the pound and the Bank of England, for lack of a better term, was long. Indeed, if the Yen was going from 100 to 200 against the USD, it is possible that the BOJ would be powerless to fight the market. After all, they can either increase rates or sell reserves. That would be a classic speculative attack on the currency such as those we have witnessed over the years, particularly in the emerging market space.

The same is NOT true in the case of a Central Bank trying to devalue their own currency as the potential supply is only limited by the speed of the printing press (which is also unlimited since most money is now electronic anyway.) In other words, if the BOJ decided to fix a floor of, say, 100 Yen per dollar, it could do so at will. Whether it decides to do so is another story, but it is mathematically feasible and, technically, easy to implement. All they have to do is buy dollars at 100:1 issuing Yen without limit.

I have no idea what will happen to the USDJPY rate in the future, or to any other price for that matter, but it is clear to me that it is impossible to force the central bank to accept a higher fiat currency than it wants. The stories may get increasingly convoluted, but the mechanisms should be clear. In my opinion, the explanations we hear have more to do with attempting to justify market moves than with real facts.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.