Recently, while many were celebrating St. Patrick’s Day, the Group of Seven (G-7) nations took decisive action in the financial markets. For the first time in over a decade, they coordinated their efforts to intervene in foreign exchange markets with a specific aim: to devalue the Japanese yen.
In the wake of Japan’s devastating earthquake, tsunami, and subsequent nuclear crisis, an unexpected development occurred—the yen strengthened instead of weakening. Remarkably, it surged.
As reported by Bloomberg, “The yen surged 4.5 percent in a mere 26 minutes on March 17, reaching a post-World War II high.” This increase was driven by concerns that Japanese investors would start converting their foreign investments back into domestic assets to fund reconstruction efforts. Recognizing this potential mass repatriation, traders acted to further bolster the yen.
For significant exporting nations like Japan, a stronger currency can be detrimental. It makes their products more expensive for international buyers, leading to reduced demand. Consequently, the U.S. Federal Reserve, along with central banks from Canada, Japan, the European Union, the UK, France, Germany, and Italy, collaborated to devalue the yen using their citizens’ financial resources.
Japan’s Finance Minister, Yoshihiko Noda, remarked that these coordinated interventions are aimed at mitigating the adverse effects of a strong yen on the economy.
A Brief Historical Perspective
Since the fall of the Berlin Wall, the Japanese economy and its stock market have struggled to achieve sustained growth. Although there have been brief periods of recovery and optimism, they have often been followed by disappointing downturns.
The stark reality is that on December 29, 1989, the Nikkei 225 index closed at 38,916 but plummeted to 9,206 last Friday, marking a decline of 76 percent over two decades. Those who invested in stocks back in 1989 may face a lifelong wait to merely break even—if that is even possible.
Amid a series of unfortunate events, there may finally be capital flowing back into Japan. While a stronger yen could reduce the competitiveness of Japanese exports, it may also lower the costs associated with reconstruction. Thus, a stronger yen isn’t entirely unfavorable.
After a momentary success in lowering the yen’s value during last Thursday’s intervention, by Friday, it had regained much of its losses against the dollar. Furthermore, as the impact of the G-7’s intervention fades, it’s likely the yen will strengthen again in the foreign exchange markets.
But what are the broader implications of these actions?
A Thoughtful Approach to Currency Markets
It’s possible that the G-7’s coordinated intervention will succeed in devaluing the yen and bolstering Japan’s delicate economy. However, government manipulation of markets often leads to unintended consequences that can be far more harmful than beneficial.
The historical track record of central bankers in achieving stable monetary values is poor. As Jeff Snider of Atlantic Capital Management notes, “The Plaza Accord of 1985 was designed to depreciate the dollar at the expense of the yen and the German Mark. It was so successful that another agreement was needed just two years later to stop the dollar’s decline.
“The second accord had little effect, and the yen continued to rise until Japan’s asset bubbles burst—partly because its yen-dependent export economy couldn’t keep up with rising asset prices.”
We all recall what followed. After the collapse of Japan’s stock and real estate markets, the country entered a recession that has lingered for over 20 years.
Ultimately, who stands to gain and who will suffer from these interventions? Central bankers appear to have little understanding, if any at all. If there were sound, stable monetary systems in place, such drastic measures would be unnecessary.
Sincerely,
MN Gordon
for Economic Prism
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