Case: The Japanese yen
Case: The Japanese yen
"The currency of Japan is the Japanese yen. The authorities of Japan do not maintain margins in respect of exchange transactions, and exchange rates are determined on the basis of underlying demand and supply conditions in the exchange markets. However, the authorities intervene when necessary in order to counter disorderly conditions in the markets. The principal intervention currency is the U.S. dollar. . . . Authorized banks may freely carry out spot and forward exchange transactions with their customers, nonresident banks, and among themselves. Forward exchange contracts may be negotiated against foreign currencies quoted on the Tokyo exchange market and in other major international foreign-exchange markets. There are no officially set rates in the forward market, and forward exchange transactions are based on free-market rates. There are no taxes or subsidies on purchases or sales of foreign exchange."
Thus the yen is very different from the peso described in the previous chapter. It is a floating currency that is not subject to the same types of controls as the Mexican peso.
The yen was trading at 251 yen per dollar as recently as 1985. As noted in Table 8.1, by mid-1985 the dollar began its long slide against the yen, and by the end of 1988 it was worth only 125.85 yen. However, 1989 and early 1990 were a period of weakening of the yen against the dollar. The dollar rose to 132.05 yen at the end of the first quarter of 1989, 144.1 at the end of the second quarter, 139.3 at the end of the third quarter, and 143.45 at the end of the fourth quarter.
These moves in late 1989 went against conventional wisdom. Most economists felt that the yen would move to 100 yen per dollar by the end of 1989, but a number of domestic and international problems tempered
that enthusiasm in 1989. A stock scandal including many of Japan's top political and business leaders (the Recruit Scandal), the massacre in Tiananmen Square in China, and the proposed unification of East and West Germany led to a weakening of the yen. In addition, there was a great deal of confidence in the U.S. government's ability to manage its economy. As noted in Table 8.1, however, there was a huge gap in dollar-denominated and yen-denominated securities, driving up the demand for dollars. Part of the difference in interest rates was explained by the difference in consumer prices, but investors could still get a relatively higher real return on investment in securities in the United States.
There were clearly some trouble spots in the Japanese economy. The stock market began a decline in late 1989, and inflationary pressures were beginning to rise. In early 1990 there was an open debate between the Ministry of Finance and the Bank of Tokyo over what the interest-rate policy should be. That debate drove the stock market down even further and shook investors' confidence in the Japanese government's ability to manage the economy and, therefore, the exchange rate.
Even though Japan had enjoyed the world's largest current-account surplus (excess of exports over imports), that surplus had fallen by one third since 1987 due to the huge outflow of Japanese capital. Since prices on Japanese assets, especially land and buildings, have risen dramatically in recent years, Japanese investors have found that they can get a better yield
on their money outside of Japan. Thus the Japanese invested $26 billion overseas in 1989, up 21 percent from 1988. Their export of capital actually exceeded their current-account surplus.
As the fear of inflation began to rise in Japan, the natural response would have been to increase interest rates. The governor of the Bank of Japan decided to increase interest rates in December 1989, but the furor that ensued caused him to delay any further increases. Given that interest rates in the United States were also high at the time due to inflationary concerns, the demand for yen fell and the demand for dollars rose, increasing the price of the dollar in terms of yen. Although the yen was falling, the Japanese government couldn't figure out how to deal with it. In the first three months of 1990, the Bank of Japan used 17 percent of its foreign-exchange reserves to sell dollars for yen, hoping to prop up the yen. The United States contributed to this effort by selling dollars for yen, but it didn't want to push the dollar down too much for fear of losing the battle against inflation. Both Japan and the United States tried to convince the governments of other countries, such as Germany and Britain, to go along, but the U.S. government wanted those countries to use their own currencies rather than U.S. dollars. However, the market realized that intervention would not solve the problems, and that the solution lay in interest-rate policy.
By the end of summer 1990, many analysts were predicting that the yen would be at 160 yen to the dollar by the end of 1990. However, the U.S. economy began to weaken, and interest rates came down as the government tried to avoid a recession. The Gulf crisis momentarily strengthened the dollar against the yen, but the economic fundamentals were more
important. As yen interest rates rose and dollar interest rates fell, the demand for the dollar fell, and so did the price. By the end of 1990, the yen was hovering at 130 yen per dollar, after experiencing a high of 124.33 in the previous 12 months and a low of 159.79.
"The currency of Japan is the Japanese yen. The authorities of Japan do not maintain margins in respect of exchange transactions, and exchange rates are determined on the basis of underlying demand and supply conditions in the exchange markets. However, the authorities intervene when necessary in order to counter disorderly conditions in the markets. The principal intervention currency is the U.S. dollar. . . . Authorized banks may freely carry out spot and forward exchange transactions with their customers, nonresident banks, and among themselves. Forward exchange contracts may be negotiated against foreign currencies quoted on the Tokyo exchange market and in other major international foreign-exchange markets. There are no officially set rates in the forward market, and forward exchange transactions are based on free-market rates. There are no taxes or subsidies on purchases or sales of foreign exchange."
Thus the yen is very different from the peso described in the previous chapter. It is a floating currency that is not subject to the same types of controls as the Mexican peso.
The yen was trading at 251 yen per dollar as recently as 1985. As noted in Table 8.1, by mid-1985 the dollar began its long slide against the yen, and by the end of 1988 it was worth only 125.85 yen. However, 1989 and early 1990 were a period of weakening of the yen against the dollar. The dollar rose to 132.05 yen at the end of the first quarter of 1989, 144.1 at the end of the second quarter, 139.3 at the end of the third quarter, and 143.45 at the end of the fourth quarter.
These moves in late 1989 went against conventional wisdom. Most economists felt that the yen would move to 100 yen per dollar by the end of 1989, but a number of domestic and international problems tempered
that enthusiasm in 1989. A stock scandal including many of Japan's top political and business leaders (the Recruit Scandal), the massacre in Tiananmen Square in China, and the proposed unification of East and West Germany led to a weakening of the yen. In addition, there was a great deal of confidence in the U.S. government's ability to manage its economy. As noted in Table 8.1, however, there was a huge gap in dollar-denominated and yen-denominated securities, driving up the demand for dollars. Part of the difference in interest rates was explained by the difference in consumer prices, but investors could still get a relatively higher real return on investment in securities in the United States.
There were clearly some trouble spots in the Japanese economy. The stock market began a decline in late 1989, and inflationary pressures were beginning to rise. In early 1990 there was an open debate between the Ministry of Finance and the Bank of Tokyo over what the interest-rate policy should be. That debate drove the stock market down even further and shook investors' confidence in the Japanese government's ability to manage the economy and, therefore, the exchange rate.
Even though Japan had enjoyed the world's largest current-account surplus (excess of exports over imports), that surplus had fallen by one third since 1987 due to the huge outflow of Japanese capital. Since prices on Japanese assets, especially land and buildings, have risen dramatically in recent years, Japanese investors have found that they can get a better yield
on their money outside of Japan. Thus the Japanese invested $26 billion overseas in 1989, up 21 percent from 1988. Their export of capital actually exceeded their current-account surplus.
As the fear of inflation began to rise in Japan, the natural response would have been to increase interest rates. The governor of the Bank of Japan decided to increase interest rates in December 1989, but the furor that ensued caused him to delay any further increases. Given that interest rates in the United States were also high at the time due to inflationary concerns, the demand for yen fell and the demand for dollars rose, increasing the price of the dollar in terms of yen. Although the yen was falling, the Japanese government couldn't figure out how to deal with it. In the first three months of 1990, the Bank of Japan used 17 percent of its foreign-exchange reserves to sell dollars for yen, hoping to prop up the yen. The United States contributed to this effort by selling dollars for yen, but it didn't want to push the dollar down too much for fear of losing the battle against inflation. Both Japan and the United States tried to convince the governments of other countries, such as Germany and Britain, to go along, but the U.S. government wanted those countries to use their own currencies rather than U.S. dollars. However, the market realized that intervention would not solve the problems, and that the solution lay in interest-rate policy.
By the end of summer 1990, many analysts were predicting that the yen would be at 160 yen to the dollar by the end of 1990. However, the U.S. economy began to weaken, and interest rates came down as the government tried to avoid a recession. The Gulf crisis momentarily strengthened the dollar against the yen, but the economic fundamentals were more
important. As yen interest rates rose and dollar interest rates fell, the demand for the dollar fell, and so did the price. By the end of 1990, the yen was hovering at 130 yen per dollar, after experiencing a high of 124.33 in the previous 12 months and a low of 159.79.
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