Yen Carry Trade: Dire Threat or Poltergeist?

In May 2006, global investors and hedgies got spooked when the BOJ ostensibly withdrew excess liquidity of JPY12.2 trillion from the Japanese banking system. While much of the so-called excess liquidity in Japan was actually smoke and mirrors, the mere anticipation of a sudden shrinkage of available liquidity caused a global sell-off. Emerging markets like India gave up 30% in a month. U.S. stocks fell. Gold and oil retreated fast.

In effect, investors ran for cover in much the same way as an air raid siren in war-torn London during World War II. When the all clear signal was given, the hedgies and investors went back to their risk-taking ways.

Yet while hedgies and global investors were fixated on the dangers of the yen carry bugaboo, a subprime credit crunch came up and bit them on the butt. The feared yen carry debacle never really happened (at least to the degree feared), but the subprime liquidity-evaporating credit crunch continues today.

In fact, the growth of the yen carry trade is part of the same financial soup that created the explosion of structured credit in the US housing market and soaring BRICs and commodity markets, each driven by excess liquidity created through monetary inflation and easy credit that encourages excessive risk taking.

In this regard, a sharp reversal in the yen that is negative for the Nikkei 225 is also negative for emerging and commodities markets, because the same factors (i.e., the subprime-instigated credit crunch) that squeeze liquidity and push the yen sharply higher also triggers simultaneous sell-offs in emerging and commodities markets and general contagion in global stock markets.

But we see the yen carry as a more of a poltergeist rather than a dire threat in and of itself. as a) the MOF/BOJ can be expected to circle the wagons on the yen from JPY100/US$ onward, and b) further rapid deterioration of the US dollar would create a consensus for multilateral, coordinated intervention to support the dollar, we do not expect to see the yen under JPY100/US$ for any length of time, if at all.

Comments

[ikkyu:]

So how much bread does the MOF/BOJ have to throw into such protective actions? With debt at 176% of GDP how much can the manipulators manipulate in your opinion? Their track record is not stellar, is it?

cheers from osaka,
john

2007 Nov 19 05:38 AM

[Darrel Whitten:]

John;

The BOJ is the agent for the MOF in effecting forex intervention, using the Foreign Exchange Fund Special Account, which has two elements, the Foreign Exchange Fund and the narrowly defined Foreign Exchange Special Account. The former is a separate fund prepared for foreign exchange trading by the Government, and purchases/sales of foreign exchange by this fund are not recorded as the revenues/expenses of the Government. In the latter, results of trading such as (1) profits/losses arising from foreign exchange trading and (2) payment/receipt of interest arising from fund-raising/investmen... accompaning foreign exchange intervention are recorded as the revenues/expenses of the Government. In this case, the government issues finance bills to fund the intervention. So, Japan's total debt would technically be affected if it were a sizeable intervention.

As for the impact, in 2001, the BOJ spent $28 billion to prevent the yen from breaking JPY100/US$, and in 2002 had to spend another $33 billion to keep the yen from getting too weak. During this period, the yen swung from JPY105/US$ to JPY135/US$, so the interventions were apparently effective.

In addition, the government is now showing massive capital gains and interest on the forex held that run into the trillions of yen, and some of these profits are being funneled back into the general account to help stop the fiscal bleeding.

2007 Nov 20 01:47 AM

[ikkyu:]

Wow, that is very fascinating and detailed information, Mr. Whitten. Thanks.

Can you tell on a daily basis when they are in action? Are they mainly buying u.s. treasuries?

I really appreciate your posts. they are the most valuable ones on japan.

Best wishes,
john

2007 Nov 20 03:02 AM

[jaycey:]

Is there something somewhere on the net that explains in a schematic fashion just how Japan deals with these surpluses? It is my view that despite the fact that they've been running surpluses for decades the old saw that "Things that can't go on forever, don't go on forever" must eventually blow up the currency pressure cooker that is the yen.

I've read a lot of "revisionist" history about Japan and it seems to me that "smoke and mirrors" is a way of life for government officials over there. It also appears that deflationary policies are a deliberate means of dealing with a yen that wants to go up because of economic forces and foreign pressure while still maintaining their sacred surplus.

Your thoughts? Links?

2007 Nov 23 05:06 PM