The Dollar And The Yen: War And Peace

Includes: FXY, UUP
by: Antonio Carradinha

Two currencies highly differentiated

The history of any country is linked to its currency. However, the diverse cultural characteristics imply that each country should make its own meaning to that reality. For example, the U.S. Dollar (NYSEARCA:UUP) is a symbol of national identity and power in relation to other countries. It is a reality that is felt globally and led several countries to value their currency based on the dollar. We may say that the dollar is a currency with strong universal value.

Japan considers its currency in a different way as Japan's economic fate has been closely linked to the Yen (NYSEARCA:FXY). Transactions with the United States are intense, and the exchange rate between the two currencies is important for both countries with repercussions throughout the world. Especially now that the global market is much more open and that transactions in dollars continue to dominate, but there are other factors to consider as I will mention later.

I consider that currencies are generally dependent from the following economic fundamentals:

- Difference between rates of monetary growth. A higher growth in relation to another currency tends to translate an increase in the exchange rate.

- Difference between rates of economic growth. A higher real growth rate of a country over another attracts a larger volume of foreign investment thus increasing demand for its currency that will likely appreciate.

-Difference between interest rates. A higher interest rate in relation to another currency facilitates an appreciation in the exchange rate.

- Difference between expected inflation rates. A relative increase in the inflation rate of a country favors the devaluation of its currency.

There may be conflicting factors and very strong monetary policies to influence the market. However, we know that the market is never perfect, and we are also aware that, in the end, it will always be the market to set the exchange rates.

At the present level of globalization, exports are a very significant economic indicator that affects any county's growth and employment rate. Thus, my study of the exchange rates of these two major currencies has as its focal point the performance and development of their respective countries' exports.

For better clarification of their movements, I will analyze in greater depth the two currencies separately.

The dollar is an open book

I am going to use the US Dollar Index, which is a trade-weighted index, as a measure of the value of the dollar, calculated by factoring the exchange rates of six of its global competitors as follows: The euro (57.6%), Japanese yen (13.6%), British pound (11.9%), Canadian dollar (9.1%), Swedish krona (4.2%) and Swiss franc (3.6%).

Charts courtesy of at

The chart of the US dollar index is quite clear. It has revealed a huge rise since the early 80's to make a gigantic top in 1985. It was due to the policies of Paul Volcker to halt the stagflation crisis of the 1970s by raising interest rates. Then, by the Plaza Accord it was agreed to correct the excessive overvaluation of the dollar. Backed by coordinated intervention of other four big economies, the Federal Reserve eased policies and allowed the dollar to decline, and focused more on growth. In fact, the US dollar has declined heavily for 3 years to reach the low value of 85 in 1988. From this date, went sideways for about 12 years reaching 97 in late 1999. Then it managed to climb to the 120 zone in 2001-2002, where he made an intermediate top, having returned to previous levels. From 2004 until now, it has remained in a trading range between 92-71 without getting to show any distinct trend.

The yen is full of surprises

The chart of the Japanese yen shows a completely different picture. In fact, the currency began to rise consistently from 1985 to 1995, recording only a relative shrinkage in the late '80s. As stated before, G5 declared that the US dollar was overvalued, and a plan to correct the situation was announced in September 1985. The plan indicated the main current account surplus countries (Japan and Germany) would boost domestic demand and appreciate their currencies. The above mentioned coordinated currency market intervention has generated an extremely large appreciation of the yen, amounting to 46 percent against the dollar by the end of 1986. As a result, Japan's export and GDP growth effectively halted in the 1986 first half.

With a recession and the rise in its currency, Japan launched immediately strong measures to revive the economy: interest rates were brought down by three percentage points, and it was applied a strong fiscal package still in 1986. With the economy growing again, following years showed an exponential growth of production and credit as well as a disproportionate increase in real estate and the stock market. A bubble was huge to thicken and eventually burst in 1990 causing the problems of Japan's economy has continued to this day. Recently, in September 2012, the Bank of Japan announced an aggressive expansion of its monetary-easing program that made possible a rapid decline of the yen.

The persistent high value of the yen which is a heavy frustration for Japanese policy makers has been attributed in large part to sharply lower U.S. rates caused by the Fed's quantitative easing, but there are other reasons for that.

A strong yen since 2007: how was it possible?

After 2007, the carry trade lost its lure when the value of the yen shot up against the dollar and started growing fears of major problems with the subprime mortgage crisis. In fact, foreign investors lost interest in obtaining very low-interest yen to carry out purchases of assets in other currencies.

Meanwhile, the yen continued to rise and reached the lowest value in 15 years against the U.S. dollar with Y82.87 in September 2008, just after the Lehman Brothers crisis. In these complex times, the Yen has become a "safe-heaven" because there was less fear of a sudden drop in its value compared to the U.S. dollar and the Euro. Moreover, the judgment of investors was that exports could stand up to a reasonable level because there would be an additional effort to increase productivity in relation to products with highly added value.

Even with the largest public debt in the developed world, as well as deflation and an aging population, investor interest remained robust in the years that followed. On July 30, 2012, the yen had risen 33% since the collapse of Lehman Brothers. This only happened because although the yen was barely safe the dollar and the euro were much worse. Moreover, given that the global crisis was more focused in the west, Japanese exports that have been badly hurt could achieve an appreciable rise, defying straightforward logic.

United States Exports and the US Dollar

Exports are very important for the economy of both the United States and Japan. Now is the time to compare their performance over the years with the evolution of each currency.

It is appropriate to note that, in 2011, exports were worth about 14% of the Gross Domestic Product of the United States while, for Japan, they accounted for 15%. Although these figures are below the average of developed countries, in both countries exports have been assuming increasing significance in relation to GDP. Thus, one can say that they are equally important for both countries.

The United States sends to Japan 5% of its total exports while being the second largest trading partner of Japan to where this country exports 15% of the total.

Looking at the chart of U.S. exports we note that the rise is notable from 1992 until 2001, the year it was registered a setback recovered two years later. From 2004 to 2008, the increase was again steady and broad having been violently interrupted by the 2008 financial crisis. Indeed, there was a sharp decline of around 25% in 2008. Then, exports resumed its strong progression though with a stabilization throughout the year 2012.

The relationship between export growth and the U.S. Dollar evolution is not remarkable. Specifically, in the period between 1992 and 2001, exports rose as the dollar went sideways and then also climbed severely. From 2003 until September 2008, exports soared vibrantly with the dollar declining continuously, which expresses an expected situation. Following the decline in exports driven by the crisis, there has been again a strong increase in exports (except in 2012) while the dollar has gone sideways for more than 4 years.

Japan Exports and the yen: an unexpected drama

The chart of Japan's exports denotes stagnation of values ​​from 1992 to 1997 with a slight increase in the period between 1997 and 2001. Then, a small break happened, and soon afterward resumed the climb already remarkably strong that occurred from 2002 to September 2008. With the financial crisis, there has been a sharp drop of about 55% but some recuperation took place soon after, in 2010, to reach a similar level to 2006. Since then, exports have failed to recover and even showed a small decrease at the end of 2012. Levels prior to the collapse of Lehman Brothers are still far and currently exports still record a decline since then of about 30%.

About the relation between the Yen and Japan's exports, we see that things went differently. In fact, during the time that exports rose slightly between 1992 and 2001, the value of the Japanese currency had an extreme increase until 1995, then had a huge fall until 1999 and increased again with force. From 2002 until September 2008, export growth was remarkable while the yen showed some initial climb following some volatility without a well defined direction. From 2009, the yen had an almost continuous rise until the end of 2011, at a time when exports were unable to rise. The rise of the yen was undoubtedly quite excessive and harmed the Japanese economy. The aggressive monetary policy in late 2012 could bring down the yen by more than 15% in a couple of months. Reflexes are expected in relation to the recovery of exports which are still unknown.

Now, what will happen?

In the chart above, we have the average monthly exchange rate of the USD/JPY since 1998. Forgetting the minor variations and normal volatility, we can see that there is a clear downward trend over the very long term of the U.S. dollar against the Japanese yen. One thing is certain: the strong dollar policy is an image earned and not exactly a reality. In the case of the yen, it should have come down to help the Japanese economy and its exports.

Is this the only conclusion to draw? I don't think so. I believe that, for a long time, the two currencies have gained importance in the aspect of attracting foreign investment. More significant still is the fact that they were also able to make the deployment of companies of both countries abroad investing heavily to increase its market share in the global economy.


What I wrote above allows me to conclude that both the U.S. Dollar and the Japanese Yen often assume asymmetric behavior in relation to exports. It is well proven that there are other reasons that influence their growth and sustainability. It was evident that exports may increase in any of these two countries if the products and services have high quality and innovation to attract buyers worldwide. All this can happen even with prices of the two currencies which at first glance might seem negative and disabling of favoring trade balance. Sure exports may increase with low prices of currencies but is not a prerequisite. It will be very important to rule out extreme situations not only on the exchange rate but also on the economic and financial order that could undermine the normal development of exports.

For example, in September last year, the yen reached a very high value and the Japanese authorities concluded the need to ensure at all costs depreciation of the yen.

I would say that it is not an incorrect policy in order to prevent extreme situations, but all economic fundamentals should be synchronized in Japan which does not seem to be the case.

Regarding the United States, the currency has also a very significant role in debt management as a strong dollar attracts foreign capital. Again, excesses are harmful, so is the whole economy that should be focused on certain crucial objectives, such as growth, inflation control and balance sustained. Moreover, the Federal Reserve maintained its weak-dollar policy through various monetary easing programs always within appropriate limits. It is a kind of caution because the effects are mainly directed to economic growth.

Since two decades, Japan has seen substantial growth problems while the United States has achieved reasonable results in this chapter. Moreover, both have suffered from problems with debt and have given more importance to exports. Both economies have carried out an excessive budget deficit that needs a strong management. While Japan walks two decades ago to fight deflation and lack of economic growth the United States are undecided on how to harmonize growth and budget deficit.

Apparently, regarding currencies, the yen will be as usually facing the front line fighting the Japanese economy, and always trying what often fails. In the case of the Dollar, there may be a higher resting stance given that it is only necessary to keep the relatively small trading range of recent times. This aim may not be easy but is certainly feasible if problems are attacked decisively.

If foreign investors consider the U.S. economy has shifted in a positive direction, it will surely favor the continuation or extension of foreign capital investments.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.