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Since last Friday, when the US Treasury conducted a so-called “rate check” of market participants, the yen has jumped from around ¥159 per dollar to hold levels close to ¥153. It is a sizeable move, and while it remains unclear whether any intervention actually took place, the signalling by the US and Japan was the closest thing short of it. Intervention to strengthen the yen is unlikely to do much good, but equally, it is unlikely to do much harm. The bigger question to ponder for Japanese prime minister Sanae Takaichi — and her electorate — is why the yen is so persistently weak.
Intervention is unlikely to do much good because of the basic trilemma of international economics. The trilemma states that it is not possible to have all three of a fixed exchange rate, free movement of capital and an independent monetary policy. Since there is no plan to stop Japanese citizens from moving their capital in and out of the country, or to prevent the Bank of Japan from setting interest rates as it sees fit, it follows that the authorities will be unable to fix the exchange rate. Empirical studies of currency intervention suggest there is a short-term impact on market prices that quickly dissipates.
Intervention is unlikely to do much harm because the yen is, according to most estimates, extremely cheap. Japan has large foreign currency reserves — accumulated decades ago, during interventions when it was trying to hold the yen down, rather than prop it up — and converting some of those reserves back into yen at today’s advantageous exchange rates will realise a sizeable profit. As long as Japan does not try to fight the markets with massive, open-ended intervention, purchases now will most likely work out as a good trade, and not something the country has cause to regret.
Whether intervention is verbal or actual, it may succeed in stabilising the yen for a few weeks, and with Japan going to the polls for a general election on February 8, Takaichi will be happy enough with that. The weakness of the currency, however, shows the downside of her populist fiscal policies. They include a proposal to suspend consumption tax on food for two years, on top of the large stimulus package she passed last November. Takaichi’s political imperative is to lower the cost of living, which has become the number one issue for the public, now that inflation has returned in Japan.
While the country was suffering deflation, fiscal stimulus made sense in order to bolster demand and use spare capacity in the economy. Now that Japan has inflation, however, it is hard to understand the economic rationale: extra spending and borrowing by the government is likely to push up interest rates without much benefit to activity. Even more seriously, populist fiscal policy could raise concerns about Japan’s large public debt. The risks of a debt crisis are often overstated and there is little imminent danger. Nonetheless, if you are one of the world’s largest sovereign debtors relative to GDP, you should be prudent with the public finances unless there is good reason to act otherwise.
The yen’s move was especially large because of the implication that the US Treasury might get involved in co-ordinated intervention. Its interest in the matter is clear: the weaker the yen, along with other Asian currencies such as the Korean won, the harder it is to reduce the US trade deficit. But just as it is at the Japanese end, the US trade deficit is driven by the fundamentals of supply and demand in the economy. Intervention in the yen is a flashy way to appear to be taking action, but if they want an actual appreciation in the Japanese currency, decision makers on both sides of the Pacific should look at policies closer to home.
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