The Yen, Nikkei, and G7
October 27, 2008
The yen has advanced to levels where Japanese companies may seriously consider relocating production abroad. The record dollar/yen low of 79.85 on April 19, 1995, gives a misleading sense of how close Japan’s currency is currently to unchartered waters. In 1995, which saw Japan’s economy slide into recession, the yen was stronger than 90 per dollar for less than five months and stronger than 100/$ for less than eight months. The yen has soared 49.6% against the euro since hitting a record low against that currency on July 23rd and is 20% stronger on a trade-weighted basis than at end-September. Japan is already in recession. What is now at stake is that the rising yen and resulting plunge of Japanese share prices may transform a mild and brief recession into a much bigger downturn.
The Nikkei’s close today of 7163 was not only below the 2003 cyclical low of 7604 but as low as such had been since October 1982. The Nikkei peaked in late December 1989 at 38916. The DJIA ended a prolonged bull run at 777 in August 1982, just three months prior to the last time the Nikkei was as weak as it got today, but Japanese real GDP is 75.5% larger now than at the end of 3Q82. Meanwhile, the DOW peaked at 14165 about a year ago. Japan’s experience strongly suggests that the 7197 DJIA low in 2002 will get taken out. If the United States endures a Japanese-like L-shaped recession with a sharp front-loaded decline, it’s not too inconceivable to imagine the Dow sinking another 1500-2000 points.
Japan can ill-afford to have the yen trade at current- or stronger levels. Neither can the rest of the world risk a shock of such magnitude to hit the second biggest nation-state economy after the United States. The G-7 statement is a protest against possible ramifications on growth, as well as excessive yen appreciation per se. As noted on this site earlier, the G-7 only mentions a specific member currency when it strongly wants recent excessive movement in the misaligned currency to be partly undone. A statement like today’s can herald concerted intervention. Since the yen is up as a result of a global financial crisis, which has not been very responsive to many other policy changes, why not try concerted intervention in yen as a backdoor way to contain the broader turbulence?
But French Finance Minister Lagarde clarified subsequently that concerted intervention is not the G-7’s plan or intent. Putting aside that she is not in position to decide what the G-7 might or might not do collectively depending on future FX developments, her remark pits French against Japanese currency policy interests, an ironic twist for the two G-7 members who have tended over the years to meddle most in the currency markets. Even if prophetic, Lagarde’s point does not really remove a serious intervention threat. Concerted intervention tends to be more effective than unilateral intervention by a government with a very weak currency. It is much easier for a government with a strong currency to cap that strength unilaterally. All it needs to do is flood markets with its currency. At the very least, the G-7 statement serves notice that other countries will not object if that is in fact done.
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