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How do we know that foreign funds are being repatriated into Japan? Because the yen strengthened against the dollar after the earthquake and until the G7 intervened. Why did the yen strengthen? Because funds were being repatriated, or will be.
Circular logic if ever there was any. In truth, the above is a simplistic representation of arguments that the repatriation of funds is putting upward pressure on the JPY, so admittedly we’ve just knocked down something of a strawman.
Sorry. Even so, these thoughts from Lombard Street are quite useful as a corrective, even to more nuanced versions of the above argument:
The yen's rise was attributed to the view that Japanese institutions would repatriate foreign assets in order to fund the reconstruction effort. But there is no evidence that such repatriation is or is about to take place. Several insurance companies have said that they have sufficient reserves to meet what may ultimately be relatively modest claims (earthquake insurance is covered jointly with the Government and private insurers exposure is limited). There has also been commentary that households will contribute to a strengthening yen as they too hastily repatriate funds. But it is not clear why this should be the case, given that relative returns between investing in Japan or overseas have not changed much "“ indeed if anything they have moved in favour of greater household outflows from Japan.
Not a point you hear often enough (unless you read your daily FT Alphaville, of course).
And in addition to 1) the lack of repatriation evidence, 2) the sudden rise in the Bank of Japan’s current account, and 3) the possibility that the BoJ might yet take the opportunity to finally do something about Japan’s deflation problem through unsterilised intervention — well, just look at the fundamentals, writes Lombard:
A shock from a natural disaster reduces the supply potential of an economy so that the real exchange rate should fall. (This would not be the case if a large part of the labour force was affected or emigrated, but this is not the case here.) In addition, for the next few months at least, Japan's export capabilities have been diminished, while its demand for imports will increase (especially for oil and gas). At the margin this too should put downward pressure on the yen. Capital flows could also serve to undermine the currency, especially if supply chain problems for specific components and products result in companies diversifying supply out of Japan. This would be in addition to the existing trend of Japanese companies relocating significant manufacturing operations elsewhere in Asia to take advantage of lower costs. As the chart above illustrates the yen's real effective exchange rate has been on a declining trend for the last decade, interrupted only by the global financial crisis in 2008/09. A falling real exchange rate reflects Japan's relatively poor supply-side performance relative to other economies in recent years. …
Preliminary estimates of the damage caused by the earthquake and tsunami have been up to ¥20trn, 4% of GDP. Given the low potential growth rate, such extra growth may help substantially erode or even eliminate the negative output gap, hastening the end of deflation. By pushing up JGB yields this would focus attention on Japan's public finances, which are about to become even more unsustainable. There will inevitably be a significant fiscal response, probably running to several trillion yen, as the Government kick starts the reconstruction effort. The funding for this will come through higher public sector borrowing, given the weakened state of the economy. A further deterioration in the fiscal position combined with an end to deflation/return of inflation would be a recipe for a fiscal crisis and a much weaker currency.
There’s a good chance that last week’s G7 decision will one day be looked back on as a “successful” intervention — that is, one that had its intended effect and the effect lasted.
We suspect the effect will indeed last (in the medium-to-long term), but it will probably owe more to the reasons given above than to the intervention itself.
Related links: The Bank of Japan’s big chance – FT Alphaville What’s moving the yen? – FT Alphaville
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