Japan Faces Flight to Quality With Brutal Yen Repeating '95

Christopher Anstey, Monami Yui and Kazumi Miura, ©2012 Bloomberg News

Wednesday, June 6, 2012

June 7 (Bloomberg) -- Investors seek the yen as a haven from turmoil sparked by a debt crisis, sending it to a postwar high against the dollar and threatening to deepen Japan's economic stagnation. The year: 1995.

It's deja-vu for Japanese policy makers, who 17 years ago countered the surge in the yen with record intervention in the foreign-exchange market, driving it down by about 30 percent within five months. Like then, the currency is again trading at postwar highs, undermining Japan's recovery from last year's earthquake and tsunami as investors seek refuge from Europe.

The one difference is intervention may not be effective, as U.S. opposition contrasts with the American and European cooperation in yen sales that helped make the 1995 operations a success. Also making the task tougher is a strengthening in Japan's status as the world's largest net creditor, bolstering the yen's allure in times of global financial stress as investors gird for a potential Greek exit from the euro.

"It's very, very difficult for the authorities in Japan to dilute the currency as a safe-haven instrument," said Paul Mackel, head of Asia-Pacific currency research at HSBC Holdings Plc in Hong Kong. "The periodic moves to create shock and awe have only worked very temporarily."

Unilateral Sales

Two rounds of unilateral yen sales last year failed to have a lasting impact, with the currency at 79.45 per dollar as of 3 p.m. in Tokyo, up from this year's low of 84.18 in March. Acting at the Ministry of Finance's behest, the Bank of Japan spent a record 8.07 trillion yen ($103 billion) Oct. 31 to bring the currency down from the record 75.35 yen that day. Japan sold at least 14.3 trillion yen in last year's interventions.

Backing the yen's haven status is Japan's increase in net foreign assets, which amounted to 54 percent of gross domestic product in December, up from 13 percent at the end of 1994, according to data compiled by Bloomberg from Finance Ministry figures released May 22. Current-account surpluses mean Japan doesn't need to rely on overseas investors to fund a public debt load that's more than twice the size of the economy.

"The yen will remain strong," Tomoya Masanao, head of portfolio management for Japan at Pacific Investment Management Co., which runs the world's biggest bond fund, said at a Tokyo conference June 1. 

"Any large-scale intervention by MOF would need to be paired with?large-scale monetary easing by the BOJ for the move to be a game?changer," which is unlikely, he said.

BOJ Policy

Governor Masaaki Shirakawa has given little indication of willingness to add to the central bank's 20 trillion yen bump in its asset-purchase program this year. Minutes of the BOJ board's April 27 meeting released last week showed that "members made note of some misunderstanding that the bank would continue to increase the size of its program in an automatic manner."

The central bank chief says excess monetary loosening raises the risk of asset-price bubbles, and told lawmakers at the Diet on May 31 that the foreign-exchange market has been affected by swings in investor appetite for risk. He said at a forum in Tokyo June 4 that the bank is monitoring the impact of yen gains on the economy. The BOJ next gathers June 14-15.

Finance Minister Jun Azumi explained to his Group of Seven counterparts on a June 5 conference call the yen's jump is causing "serious damage" to Japan's economy. He told reporters in Tokyo after the call that he wanted members to observe past G-7 statements against "disorderly movements" in currencies. He said "there was no particular response" to his comments.

Rubin's Dollar

Seventeen years ago, it was the danger of a Mexican financial collapse contaminating the U.S. economy that propelled the yen. What helped secure coordinated intervention was U.S. Treasury Secretary Robert Rubin's effort to enforce his policy of having a "strong" dollar. Rubin said the stance could help contain inflation, with the jobless rate at about 5.5 percent, compared with more than 8 percent now.

With Germany also joining in, interventions by August 1995 were "quite effective," according to a 2002 study by Takatoshi Ito, a former Finance Ministry official who is now a professor at Tokyo University. The yen, having started the year at 100.20 per dollar and soared to as high as 79.75, ended 1995 at 103.52, according to data compiled by Bloomberg.

This time round, with the euro falling against the dollar and U.S. policy makers seeking to spur growth and job gains rather than to quell inflation, there's a reduced case for cooperation as countries welcome lower currencies to spur exports and bolster their economies.

U.S. Opposed

"The United States did not support" Japan's unilateral yen sales in August and October, which took place when markets were orderly and global economic developments were affecting other major currencies as well, the Treasury Department said in its semiannual foreign-exchange report in December. The U.S. did join in coordinated yen sales on March 18, seven days after Japan was struck by its most powerful temblor on record.

Eisuke Sakakibara, known as Mr. Yen when he ran currency operations at the Finance Ministry in the 1990s, said at a conference in Singapore today that "intervention could only be effective when two parties agree to intervene." Without American support, "intervention couldn't be effective," he said, adding that "it's a waste of time and waste of money."

Exports made up 15 percent of the world's third-largest economy in the first three months of 2012, up from 9 percent in the first quarter of 1995, amplifying the impact on Japan of competitiveness-sapping exchange-rate strengthening.

Impact on Profits

Each one-yen advance in Japan's currency against the dollar leads to declines in operating profit of 2.4 percent at Nissan Motor Co., 3.3 percent at Toyota Motor Corp. and 2.9 percent at Honda Motor Co., Goldman Sachs Group Inc. estimated in an April report. Yokohama-based Nissan has responded in part by shifting production to countries including Thailand.

The yen remains stronger than the 82 level at which the nation's companies said they can remain profitable in an annual government survey released in February.

Currency appreciation contributed to Japan having a record trade deficit in 2011, along with factory shutdowns and electricity shortages in the aftermath of the record March 11 earthquake and ensuing tsunami. Because of income from overseas assets, Japan's current account remained in surplus.

Economists have differed this year on whether the current- account surplus will remain, with UBS AG analysts seeing it lasting until 2050, and those at JPMorgan Chase & Co. citing the risk of a shift to deficit in 2015.

Japan's Assets

Deficits would need to be large to offset Japan's net overseas assets, which totaled 253 trillion yen at the end of last year. Past intervention in the yen contributed to the total, leaving Japanese investors as the second-largest foreign holders behind China of U.S. government debt, with $1.1 trillion as of March, Treasury Department data show.

Japan's exchange rate has soared 52 percent against the dollar since the start of August 2007, when the U.S. housing depression began contaminating world money markets, triggering the global financial crisis. The Swiss franc has been the No. 2 beneficiary of the flight from risk, advancing 25 percent, according to data compiled by Bloomberg.

Switzerland's decision in September to cap its exchange rate diminishes the franc's ability to serve as a global harbor, HSBC analysts said in a report last month. While the dollar's liquidity means "it can sometimes behave" like a haven, American reliance on foreign investors to hold almost half of the U.S. government's marketable debt means it's sensitive to any loss of overseas confidence, according to HSBC.

'Overvalued' Measure

The currency still has room to appreciate before it becomes "overvalued," when measured in inflation-adjusted terms, according to Morgan Stanley. The equivalent competitive position of the mid-1990s would be a value for the yen in the "mid 50s" per dollar, Ronald Leven, an executive director and strategist at the bank in New York, said in a May 31 report.

The yen's advance and the euro crisis have hammered Japan's stock market, with the Nikkei 225 Stock Average falling the past nine weeks, the longest losing streak since 1992. Sony Corp. saw its shares on June 4 slide below 1,000 yen in Tokyo trading for the first time since 1980.

Equities aren't reflecting the state of the economy, Azumi told reporters in Tokyo June 4.

A report on June 8 will show GDP rose a revised 4.5 percent last quarter from the previous three months, at an annualized pace, according to the median of 18 estimates in a Bloomberg News survey. The government's initial estimate was 4.1 percent. GDP shrank 2.8 percent last year, hurt by the record quake and ensuing tsunami that devastated the northeast.

GDP Outlook

The yen's appreciation raises risks for the strength of the economic recovery, JPMorgan economists said in a June 1 report. The bank currently projects 2.5 percent growth this year and a 1.3 percent expansion next year, and plans to review its outlook after this week's GDP report.

Officials' tolerance of the yen's climb may be tested around 76 per dollar, according to HSBC and Bank of America Merrill Lynch analysts. So-called "stealth interventions," where Finance Ministry officials refrain from confirming the yen sales on the day they were executed, may begin if the yen strengthens beyond the previous start level of 75.65, Bank of America Merrill Lynch said in a June 1 report.

After the Treasury's criticism, the pace of any break past 76 may decide whether Japan enters the market, according to Tohru Sasaki, head of Japan rates and currency research in Tokyo at JPMorgan, who previously worked as a senior dealer at the BOJ's foreign-exchange division.

"I see a low chance that Japan will intervene when dollar- yen breaks below 76, provided the move is slow," Sasaki said.

Another argument for holding off is the lack of a resolution in Greece, said Masafumi Yamamoto, chief currency strategist in Tokyo at Barclays Capital, and a former BOJ official. Europe's woes have deepened as concern rose that Greece may exit the euro region after its June 17 election and that Spain will need a bailout after rescuing its banks.

"The Greek situation may negate the impact of any intervention even if Japan spends a lot of money to weaken the yen against the dollar," Yamamoto said. "The timing isn't right yet to ensure maximum impact for intervention."

--With assistance from James Mayger and Mariko Ishikawa in Tokyo and Masaki Kondo in Singapore. Editors: Garfield Reynolds, Paul Panckhurst

To contact the reporters responsible for this story: Chris Anstey at canstey@bloomberg.net; Monami Yui in Tokyo at myui1@bloomberg.net; Kazumi Miura in Tokyo at kmiura1@bloomberg.net

To contact the editor responsible for this story: Chris Anstey at canstey@bloomberg.net; Rocky Swift at rswift5@bloomberg.net