Has the G7 Got It All Wrong On the Yen?

Jeremy Warner Daily Telegraph March 19, 2011

Saturday 19 March 2011 | Blog Feed | All feeds

By Jeremy Warner Economics Last updated: March 18th, 2011

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To intervene or not to intervene? Or to put it another way, to appreciate or not to appreciate? G7 leaders, by sanctioning the first co-ordinated currency intervention in more than ten years, seem to have succeeded in their purpose of driving down the value of the yen, at least for now. But is this really the right response to the crisis?

Time was when co-ordinated interventions of this sort were common place. First we had the “Plaza accord”, when the major economies ganged together in the mid-1980s to drive down the value of the dollar. At that time, the US was running a substantial current account deficit (no change there then), but thanks to high interest rates to fight inflation (hmmm), the currency was unduly strong. The intervention worked so well that eventually it had to be replaced by the “Louvre accord”, where the purpose was the reverse – to halt the dollar’s decline.

It was all pretty pointless really, and though it sort of worked in forcing the dollar to move in the way policymakers wanted, it’s at best arguable as to whether in itself it had any significant macro-economic effect. The last example of such intervention was in September 2000, when the G7 intervened to support the euro, then a new currency struggling to win credibility with international investors. Ironically, the euro crisis is today much more severe, yet the currency itself doesn’t seem to have any kind of a credibility problem with investors. Instead, they attack the eurozone’s soft underbelly through the sovereign bond markets.

In any case, enough of this potted history of co-ordinated intervention. The latest example of it has been prompted by a very rapid appreciation of the yen in the wake of last week’s earthquake and tsunami. Up until the point of intervention, the yen had appreciated by close to 10 per cent within the space of a few days, and for the first time ever had breached the 80 yen to the dollar mark.

This might seem an odd response given the scale of the catastrophe, which logically you would expect to cause the currency to plummet. The reason it rose instead is because it’s expected that Japanese investors will repatriate overseas money to pay for the distaster. Actually there’s not much evidence of this so far. As ever in markets, it’s the anticipation rather than the actuality which is doing the damage.

Over the years, Japan has learned to live with a strong currency; it doesn’t seem to have damaged its export performance very much. Yet even a country as productive as Japan would struggle to cope with a 10 per cent appreciation in less than a week. And these are hardly the best of times to make such an adjustment. For a big exporter such as Japan, currency appreciation acts like a form of monetary tightening, which right now the economy needs like a hole in the head.

Yet there is an alternative view. Here it is being put by Professor Geoffrey Wood, Emeritus Professor of Economics at Cass Business School, London.

"The G7 are making a grave mistake by intervening to control the volatility of the yen. Japan benefits from a strong yen as it will help them to increase imports, which is exactly what they need to do."

He’s not alone. Here’s Brian Reading of Lombard Street Research making much the same point.

“The disaster has reduced potential supply and increased demand. Almost certainly it will eliminate Japan's current account surplus. Excess savings, which have dogged Japan for decades, will be eliminated for some time. Both import demand and export supply will be inelastic. Can't export more, can't import less. Now is the time to cash foreign currency reserves to keep the yen up. Not only will improved terms of trade benefit Japan, but also reserve sales will help pay for the disaster without raising government debt. “

Yes, and maybe they should jack up interest rates while they are about it. That might get this high savings economy spending again – not. Personally, I find Prof Wood’s argument too clever by half. Yes, in the very short term, Japan is going to struggle to export very much at all, and the cheaper it can import everything it needs for renewal, the better. But the idea that if imports are cheaper (because of currency appreciation) Japanese households will all of a sudden change the habit of a lifetime and spend all their way back to economic growth, thus rebalancing the economy away from exports to internal demand, strikes me as most unlikely.

Actually, what a high yen will do is severely crimp the recovery in Japan’s export industries, which will eventually lead to rising unemployment and therefore lower consumption. The effect would be to add a further burst of deflation to an already seriously deflating economy.

Lack of domestic demand in Japan is not something that can be corrected through currency appreciation, as Japan’s already long history of currency appreciation amply demonstrates. Up and up the yen has gone, but it’s not boosted consumption. On the whole, the Japanese don’t buy foreign goods, however cheap they are, and an earthquake isn’t going to change that reality.

Tags: Brian Reading, Cass Business School, earthquake, G7, Geoffrey Wood, japan, Lombard Street Research, Louvre Accord, Plaza Accord, tsunami, Yen

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Has the G7 Got It All Wrong On the Yen?

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