SINCE the summer, the yen has shot up against all major currencies. It is now 23.2% higher than last year's low-point against the dollar, 46.7% higher against the euro, and 65% up against the tumbling pound. Manufacturers are screaming. Japanese exports are down by over a third compared with a year ago, and carmakers and electronics firms are slashing production and jobs. On February 2nd the Keidanren, a big-business club, declared the value of the yen, at under ¥90 to the dollar, to be manufacturers' most critical problem. They were, it said, "crying out" for the government to weaken the yen, either alone or in league with other countries.
They may cry in vain. In trade-weighted terms the currency is not overvalued by historical standards (see chart). A long undervaluation has merely corrected itself. The exporters driving Japan's recovery from 2002-07 made two false assumptions as they built new capacity: that American consumers would always buy Asian exports, and that ¥100-120 to the dollar was the sustainable long-term rate. Both were chimeras.
The yen's undervaluation was what Eisuke Sakakibara, a former vice-minister of finance, calls a "cheap-yen bubble". Exceptionally low global financial-market volatility in the middle of the decade helped spur the famous yen carry trade. Foreign banks and hedge funds borrowed yen at low interest rates which they then sold, swapping the yen into higher-yielding currencies and profiting from the yield difference. Japanese retail investors followed a similar ploy, buying quantities of foreign-currency bonds for their higher yield. Some of what they bought were structured products sold by banks that protected investors against currency losses.
Since the summer, foreigners have unwound the yen carry trade with a vengeance, driving the yen up. Not only are retail investors (and writers of structured products) sitting on capital losses; overseas yields have also plummeted. Households' holdings of overseas securities, says Tohru Sasaki of JPMorgan Chase, remain huge--¥13.9 trillion at the end of September, the latest figures available, double the amount of a year earlier. He says that with unemployment set to jump and the economy set to shrink by, say, 5.7% this year, households will bring yen home. Mr Sakakibara predicts that a climb to ¥85 against the dollar will trigger a wave of stop-loss orders, sending the exchange rate quickly to ¥80 or even ¥75. The government would then face huge pressure to intervene for the first time since March 2004.
Economist.com
