Japanese Yen: Large Corrections to a Long-Term Uptrend

January 14, 2013

Japanese politicians since the 1950s have preferred a soft and competitive yen to a rising exchange rate and have not been bashful about expressing those preferences.  Prime Minister Abe is hardly the first official to use verbal intervention to counter yen strength, but he has been particularly convincing in this quest.  Abe’s timing is good, because the yen looked objectively overvalued for most of 2012.  The currency’s strength was increasingly counterintuitive in the face of a series of recessions and the emergence of a trade deficit.  More importantly, Shinzo Abe linked the weak yen to Japan’s chronic deflation and blamed both problems on a monetary policy that wasn’t sufficiently accommodative.  Abe went where earlier politicians had not gone, demanding that the Bank of Japan adopt a 2% inflation target and seek that goal through unlimited quantitative stimulus. 

The latest policy counter-attack against an overvalued yen has been very effective.  Before this new brand of verbal intervention, markets had become generally insensitive to the verbal intervention of others, given their frequency and ineffectiveness.  But markets have paid great attention to Abe’s comments, and the yen has depreciated since the final trading session of September by 13.7% against the dollar and 16.9% against the euro to multi-year lows today of 89.70/USD and 120.16 per euro.

Investors expect the yen to trade soon in the mid-90s, and some forecasterss are postulating that the currency could retreat as far as 115/USD.  This note sheds some perspective on the current dramatic transition by reviewing the yen’s paradoxical history.  The long-term yen trend has been one of unmistakable strength, but that trend has also been interrupted by three very sharp downward corrections.

The long-term trend has not only favored a strengthening Japanese currency but has also been remarkable for the consistency of that direction.  Dollar/yen was fixed by the Bretton Woods Accord and stayed at 360 yen per dollar from 1949 until President Nixon severed dollar/gold convertibility in August 1971.  After the dollar devaluation of December 1971, the yen was repegged at 308 to the dollar.  A second dollar devaluation in February 1973 ushered in the era of flexible dollar exchange rates, which were determined mostly by market forces but with a role reserved for governments to intervene in the marketplace to counter disorderly trading conditions.  The dollar exchanged on average for 244.9 yen from 1973 through 1986, 121.9 from 1987 through 2000, 116.4 from 2001 through 2007.  And since 2008, the dollar has on average been worth 88.8 yen, which happens to be close to its present level.

The yen’s trend has been punctuated by three setbacks that were at least 25% in magnitude.

  • From a high of 176 per dollar at end-October 1978, Japan’s currency retreated to 264 in early April 1980 and 279 during October 1982.  At its corrective low-point, the yen had depreciated by 37%.  The second OPEC oil price shock was a key depressant, and the early 1980s were a time of broad dollar strength against other so-called hard currencies such as the Swiss franc and German mark.
  • The post-Plaza Accord sent the dollar on a multi-year plunge that from the yen’s perspective peaked at 120.4 around the end of 1987.  From that point to a yen low of 160.30 per dollar in April 1990, Japan’s currency tumbled 25%.  Paradoxically, the yen bottomed out just before Japan’s own banking crisis and shift to much lower growth.  Prior to 1990, Japanese growth that dipped under 3% was considered recessionary.  Now, growth averages less than 1%.
  • The third mega-depreciation of the yen occupied the period between April 1995 and February 2002 when the currency slumped 41% from a high of 79.85 per dollar to a low of 135.20.  Those years included the Asian crisis of 1997-8, the launch of the euro, and the onset of deflation in Japan.

If the yen were to now ultimately decline by 34% from its level of September 28 — 34% being the average of the above three episodes — it would eventually slide to 117 per dollar.  That level happens to be very close to the aforementioned 115/USD that pessimistic yen bears are projecting for late 2013.  Where the comparison of these forecasts to the three historic examples breaks down is the amount of time perceived for the move. The biggest yen bears are thinking of a 34% swing in the space of year, while the three big historic corrections stretched over several years.

A final point to note is that viewed over the last 60 years, the yen has seemed to be an object of stability more than volatility.  That makes the period since October an exception rather than the norm.  The annual averages of 237.5 per dollar in 1983, 237.5 in 1984 and 238.5 in 1985 was an incredibly tight shot group.  So too more recently were the mean values of 79.73 per USD in 2011 followed by 79.85 in 2012.  Prime Minister Abe’s hope is that the present yen correction not be V-shaped, that is reversing as rapidly as it’s moving now, but rather for the correction from the overvalued level since 2008 to be followed by a new equilibrium that is characterized by an extended period of stability but at a level that is much more consistent with Japan’s weakened economic fundamentals.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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