By Anjan Roy
In a significant development in world’s major financial markets, the US Federal Reserve Bank has started buying the Japanese currency, the Yen. The development was first reported in the Financial Times of London last weekend.
Subsequently, Reuters published a photograph of a note pad of Scott Bessent, US treasury secretary, during an open session in course of a meeting of the US cabinet at Camp David resort.
The photograph clearly shows a scribbling on his note-pad by Scott Bessent his “to Do” list. It marked purchases by US of “$5 to 10 billion” in JPY, that is the Japanese Yen. The decision was later on confirmed by Donald Trump observing that the Japan had requested US purchases of yen. The U.S. always stands ready to help as a friendly country, he added.
The basic idea is to shore up the exchange rate of Japanese yen against the US dollar. The yen had depreciated to a historic 40-year low against the dollar and this had impact on the relative trading positions of the two countries.
A lower yen meant that US products were costlier to Japanese consumers and they would thus stay away from imports from the United States. On the contrary, Japanese products would be cheaper in the US. The dollar has appreciated against most other major currencies in the last few years.
The continuous depreciation of the Japanese yen has been a historical fact for Japan for years now. This was because Japan had entered a stage of low inflation and low growth, which successive Japanese governments and governors of Japanese central bank had failed to reverse.
If low inflation might appear a good thing, prolonged low to negative inflation, that is deflation or falling prices, is far more potent factor in killing an economy. The problem is that if deflation takes hold, it is very difficult to reverse it and economists hardly have any tools in their boxes to fight it.
Ian a situation of deflation, or falling prices, consumers tend to defer their purchase decisions, hoping to cash in on lower future prices, If the entire economy had such expectations, then the basic driving force for th economy, that is, consumer demand evaporates. Sluggish demand means companies will not invest in the economy and there starts a vicious cycle of de-growth.
The episode was described by economists and experts as “Japan’s lost decades”. The phase of such moribund state of the interest rates. Japanese economy started after its spectacular and sterling economic performance since after the Second World War when Japan started rebuilding its economy.
In a typical situation of no-growth-no-inflation, central banks seek to reverse this by cutting down in interest rates to encourage consumers to take loans and purchase and companies to invest. Japan was the first country to witness as a result “negative” interest rates. That is, if lose a tiny part of your savings by depositing these in your bank.
With such interest rates, who will invest in Japanese financial assets. The process began for withdrawal from Japanese assets and going into competing assets in other currencies.
The inevitable result is the depreciation of the currency and exchange of Japanese yen began falling. This showed a secular depreciation over years which in the current situation has reached historic lows.
To help Japan, as a deliberate policy decision, the US Federal Reserve has been reported to have sold some of its Euro assets and put funds into the Japanese yen dominated assets last week. This might be repeated in the current week and maybe weeks ahead. But does it help? Temporarily; not in the long run.
This is because the financial markets developments reflect some inherent structural aspects of the economy. In this case, for Japan, it has become a capital exporting country. That is, even for the largest Japanese companies, they are investing in manufacturing facilities not in their home turf but elsewhere.
Most Japanese corporations have large investment abroad, including very substantial stakes in China. They have often not even repatriated their profits and surpluses back to their own country.
The combined impact of all these factors is that the demand for yen-denominated assets have come down, driving the exchange rate of the yen. Japan is now seeking to reverse this situation and wishes to see a more stable currency market.
However, unless there are some fundamental structural corrections in Japan, the manifestation of falling exchange rate or low inflation might not get reversed. (IPA Service)
