Has a New 'Mr. Yen' Surfaced?

On January 7 of this year, the day after his appointment as Japan's finance minister, Naoto Kan stated that there was a need for the yen to weaken in order to help Japanese exporters. The markets did not treat this statement lightly, for it effectively reverses the long-held position of his predecessor, Hirohisa Fujii, of allowing the value of the yen to be determined solely by market forces. Fujii-san had resigned earlier in the week due to ill health. Kan explained that he "must work with the Bank of Japan to bring the yen to appropriate levels given its impact on the economy" and that "many Japanese firms favor yen at around ¥95." The currency markets were caught completely off guard by his comments and responded by selling the yen in a panic, driving it lower by more than half a yen vs. the dollar -ultimately to ¥93.77, its lowest level versus the dollar since last August.

This knee-jerk reaction to a remark made by a Japanese finance minister reminds me (and other veterans of the currency markets) of the mid-1990's (see chart below) when another outspoken Japanese government finance official played havoc with the currency markets. Eisuke Sakakibara, then Deputy Finance Minister, was known as "Mr. Yen" for his ability to move the value of the Japanese yen simply by making remarks about the level of the Japan's exchange rate. Traders knew that he was being used as a mouthpiece by the Bank of Japan to tell the markets whether it wanted a stronger or weaker yen. Billions of dollars often hung on his every word. In the chart below we can see the V-shaped bottom of the US dollar / JPY in 1995, which was when the original Mr. Yen was most vocal and, in the end, successful in halting and turning around the market. Importantly, note that the recent daily low in the dollar at ¥86.41 in November was within a stone's throw of the daily low of ¥84.33 back in April of 1995.

  

Today, however, the currency markets are a much more formidable force than they were when Sakakibara-san held court. Current trading volumes are estimated to be $3.8 trillion per day (as per a 2008 study conducted by the Bank for International Settlements), which dwarfs the trading volumes seen back in the mid-1990's of only $1 trillion per day. Such so-called verbal intervention, as successfully practiced by Sakakibara-san, may need to be backed up by actual currency intervention by the Bank of Japan to be effective in today's market. The Bank of Japan has not officially intervened in the currency markets to weaken the yen since March of 2004.

Is a Weaker Yen Really Necessary?
Japan is still in recovery mode from its deepest postwar recession, and is increasingly vulnerable to deflation and problems related to its enormous government debt, which at 200 percent of GDP is by far the highest in the industrialized world. Japan's exports plunged last year after the financial crisis and were accelerated by a surge in the value of the yen, particularly against the dollar.

Politics Japan Style
Little is said to the press by Japan's politicians that is not politically motivated. As we have learned over the years observing Japanese politics, nothing ever really is what it seems, with plenty of activity and maneuvering below the surface that we never see. What we do know is that pressure is mounting on Prime Minister Hatoyama's Democratic party. They came into power just last September after nearly 50 years of conservative rule and they are already suffering in the rating polls. Fujii's sudden departure has added a level of uncertainty about the government's ability to handle the economy. And, to make matters worse, Japan's upper-house elections in July may determine whether the Democrats can govern without the support of two small coalition partners. So, the question is: What can or will a government, which is on the defensive, do or say that will help stimulate economic growth or at least promise convincingly that economic growth is just around the corner? Will they do just about anything? Will they engineer a weaker yen?

Who's in Charge Over There Anyway?
Just like in a script, on the day following Finance Minister Kan's comments, new Prime Minister Hatoyama calmed the markets by telling reporters that the government should really not comment on the currency markets, and then added that his Finance Minister's views were simply a reflection of business sentiment. At his side, Kan bowed apologetically (no doubt), but then he straightened a bit and stated that he himself, in his capacity as Finance Minister, reserves the right to intervene in the currency markets in extreme circumstances and after taking into account the yen's impact on the economy. So, the dynamic duo both achieved what they needed to achieve ... the Japanese way.

Well, Will They Intervene or Not?
The yen is 20 percent stronger against the currencies of Japan's trading partners than it was two years ago. So, yes, of course Japan would benefit from a weaker yen. Last November 27, as the yen rallied and the U.S. dollar dropped to its 14-year low of ¥84.83, the Bank of Japan did take a step closer to intervention than at any time over the last five years by checking exchange rates with several commercial banks (It was all that was involved — simply a phone call). Those calls, however, had the effect the bank desired: a reversal in that downtrend in the dollar. That was then, and now is now. The market may not react in the same way the next time rates are checked. Will the new Mr. Yen try to talk the yen down or will he really step up to the plate and swing the intervention bat for the first time in years? We shall see.