19 March 2011

Japan's Accidental Intervention in the Currency Wars?

The Japanese situation makes clear the need to restore democracy to the world's economy. We need to take power back from the capital markets and the speculators and return it to politicians who are responsive to their people. At a time of such dire national crisis, how can it be right that Japan's politicians have to be distracted by the need to appease those whose only interest is to extract value from the country?

The unexpected response by the foreign exchange traders to the greatest natural disaster in Japanese history was to force up the value of the Yen. As usual in economics, the raised value of the Yen cuts both way for the Japanese. In the short term it will make it cheaper for them to import the goods and resources they need to rebuild. In theory, in the longer term it will make their exports more expensive and so will impeded recovery. In fact, given the failure of electricity supplies and the consequent decline in production, this is likely to be less of a concern to the people of Japan.

It is, however, of concern to Japan's competitors. Hence the decision by the G7 countries to intervene in the foreign exchange markets by selling their stocks of Yen in order to reduce its price. The figure shows the immediate success of this market intervention yesterday, both proving the self-interest of G7 governments and giving the lie to their repeated statements that the markets rule supreme.

But why the rapid rise in the Yen (illustrated in the second graphic) in the first place, when the performance of the economy from which it arises will clearly be severely impacted by the destruction of infrastructure and power shortages? The answer appears to be that Japanese institutions and the government are expected to repatriate Japanese savings held overseas. The resulting firesale of US bonds and stocks could be the event that pulls the plug on the USA's 40-year beano at the expense of the rest of the world.

In spite of the very low returns, the Japanese and Chinese have continued to hold US debt, allowing US citizens to consume way beyond the level their productive effort merits. The power of the dollar as the global reserve currency permits this, but that power has been challenged during the recent 'currency wars'. If the Japanese crisis forces that US to the negotiating table to agree a fairer system of international exchange, it might prove to be a dark cloud with a silver lining for us all.

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