Thursday, September 16, 2010

Why Is Japan Buying US Bonds?

The recent economic crisis has led to various unusual types of economic behaviour. One example is that countries such as Switzerland and Japan have been trying very hard to reduce the value of their currency.

Japan, for example, is buying US bonds and selling Yen on markets. The Bank of Japan sold ¥1 trillion (£7bn) just yesterday.(1) They hope by buying dollar assets, they will weaken the Yen against the dollar.

Japan has two main fears.
  • Strong currency makes Japanese exports more expensive, leading to less demand and lower growth. Because Japan is seen as a relative 'safe haven' there is unexpectedly high demand for Japanese currency.
  • Japan still has deflation (-1.5%). Deflation of course can lead to lower growth and debt deflation.
They hope by creating money to buy US bonds, they will create a monetary stimulus and improve exports.

The problem is that the US doesn't want a stronger dollar either. The US fears an appreciation in the dollar will hurt US exports. The US is already dismayed at the perceived under valuation of the Chinese currency. This attempt to manipulate exchange rates is often called 'competitive devaluation' or beggar-thy-neighbour policies - because you seek to improve your prospects by making other countries less competitive.

Why is the Japanese Currency Rising? when -
  • the economy is sluggish.
  • The Central Bank is trying to pursue monetary stimulus
  • Japanese Public Sector debt is over 200% of GDP
Generally, many markets see Japan as one of the least bad options for depositing money. This year concerns over the fiscal state of Euro bonds has led to a significant revaluation of the desirability of holding Euro bonds. The Euro has become much less attractive over fears of Euro debt default. Thus investors have been seeking alternatives - such as the Swiss Franc and Japanese Yen.

It may be that it is difficult to actually weaken the Yen, because the level of intervention may be too great given markets appetite for Japanese Yen

The problem is that the demand for Japanese Yen is not so much because of strong economic growth and good prospects in Japan, but because - well it isn't the US or Euro. Thus the Japanese Yen is rising at a time when their economy doesn't need it.

One thing is certain, countries like Japan need to avoid deflation. Weakening the currency and creating money is one way of dealing with it.


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