Currency wars: context and forecast – updated

I think it is worth sketching out a little of the context in which Japan’s actions yesterday occurred.

The last time Japan intervened directly like this was ’03-04. Six years ago. Their intervention was then, as it is now, to decrease the value of the Yen in order to help their exporters. Over two years Japan spent, it is estimated, about 35 Trillion Yen. And it did not work. Almost as soon as the daily interventions stopped the Yen rose to where the market had had it in the first place.

So what we are looking at is not a re-setting of a rate but a temporary bending of it which lasts only so long as the Yen selling pressure continues. This says to me the need in Japan is critical and driven by short term fears rather than long term hopes. But Japan could print and flood the world with as much as 145 Trillion new Yen. No one knows how much of this it would ‘sterilize’ by subsequently issuing bonds to soak it up and how much it would print and leave in cirulation. One thing seems clear. After two decades of following the same expensive and broken policy, its an expensive way of putting out the light.

Let’s now look at the broader political context. Because it is worth remembering that in straightened times, global finance can be seen as a zero sum game where one person’s benefit can only come at an other’s expense. Moving currencies, in such times, when everyone feels they have something to lose, can be seen as the financial equivalent to moving armies or threatening borders.

Japan had asked for cooperation from other Central Banks. It does not seem they got any but we cannot be sure. Two Fed officials refused to comment when asked if the Fed had been told about the intervention before it happened. It will complicate US attempts to complain to China about what the US alleges is China’s ‘currency manipulation’ coming as it now does, hard on the heels of Japan blatantly manipulating the Yen.

The relation between Japan and China is also very fraught more broadly. Last week tensions between the two started to boil over, due to the arrest and detention of a Chinese ‘fishing boat’ which had strayed into waters contested by China and Japan.

The Japanese envoy in Beijing was summoned five times to be repeatedly told that China demands the release of its citizen. What is so special about the fishing boat? Nothing. What is special about where it had strayed? Everything. Basically they are having a Falklands moment.

The boat was detained near to the Senkaku islands which both Japan and China claim belong to them. And which, it is estimated, sit atop, a massive 200 billion cubic meters of gas reserves. China has been drilling for years, Japan has held off while attempting to settle the dispute, but recently gave permission to a Japanese firm to start drilling.

This has prompted a number of anti Japanese demonstrations over the disputed islands. Of course there are many demonstrations ‘allowed’ in China. But it does begin to make the dispute a matter of public and national pride. And we know how that can end.

Both China and Japan are huge net importers of oil and gas. SO neither is going to shrug and walk away.

China is also showing itself to not be Japan’s friend, directly on the currency front as well. So far this year China has seen fit to buy about 27 billion dollar’s worth of Japanese bonds which has only added to the upward pressure on the value of the Yen. This isn’t an accident. $27 billion dollar’s worth is six times the amount China bought in the last five years combined.

All this comes at a very sensitive time for Japan. Only a few weeks ago Japan suffered the humiliation of being supplanted by China as the world’s second largest economy. I think it quite likely that Japan does not feel as secure as it once did. Not secure in its financial position and no longer sure of its allies.

It will be very interesting to see what the US does in this dispute. I think Japan in particular will read American actions with great attention. Since WWII the US has clearly and unambiguously supported the Japanese claim to the islands and surrounding coastal exclusion zone. It is there in writing in several declarations. Japan will be attuned for any wavering in that support. If the US shows any sign of seeming to side at all with China, Japan would, I think, be quite correct to see it as a clear indication of being forsaken by their erstwhile ally in favour of a rising power. How then to say to Japan, ‘work with us toward a greater good even if it costs you’?

Where Europe sits in this is I think still wide open. Europe has clearly broken from the US. America’s best option is to see and facilitate Europe’s break up. A divided Europe will be less able to threaten America’s interests and power. But a weakend though not broekn Europe will ironically help them as a whole. Greece has allowed the devaluation of the Euro without anyone needing to manipulate anything.

Europe’s relation to Japan could alter but it will depend on how Germany and Japan reconcile their areas of competition. Japan has better relations with France. What the always Perfidious Albion does hangs in the balance. It will depend on how will people react to the final dawning of what the budget cuts really mean. We will see this autumn.

All in all I think we are entering a time of great volatility in political alliances over and above the volatility in currency values. But each will feed into and amplify the other.