Intervention in the Yen — and the Huge Opportunity for You!

Japan’s currency has gained nearly 40 percent against the dollar since the economic crisis erupted in the middle of 2007. And 8 percent of the yen’s gains came during the past week despite the devastation from the earthquake, the Tsunami and the ongoing nuclear fallout.

Of course Japan can’t control the natural disaster or the ramifications from the nuclear fall-out. It CAN, however, control the value of the yen. And with support from its G-7 counterparts it began doing just that yesterday morning in Japan when the Bank of Japan (BOJ) stepped in to reverse the yen’s upward spiral.

Will it work?

Japan’s Aggressive Record
of Weakening the Yen

Japan has a reputation for being sensitive to movements in the currency markets and for taking action. Its heaviest periods of intervention tended to coincide with slower economic growth rates — like it’s experiencing now — especially given the threats and uncertainty represented by this past week’s events.

The last time Japan intervened to weaken the yen was last September, when it stepped in to weaken the yen by 3.5% in a day — its biggest one-day intervention on record. But it didn’t work, because the BOJ wasn’t persistent.

Back then the world was pressuring China to stop manipulating its currency. So the BOJ was in jeopardy of fracturing the global political landscape by imposing its will on the strong yen.

Prior to September, the last time Japan intervened to weaken the yen was between 2003 and 2004 …

Yesterday, the BOJ took action to drive the yen lower.

Over the course of 126 days the BOJ sold yen in the open market to purchase 315 billion U.S. dollars. These steps ultimately sent the yen 11 percent lower.

But the overall success of interventions in changing the long-term path of a currency is not great. A lot depends on how it’s done …

Changing the path of a currency tends to have a higher success rate when countries act together in support of (or against) the same currency. These coordinated interventions also have a greater spillover effect on other currencies.

For example, between 1999 and 2000, both the Fed and the BOJ coordinated to put a floor under the dollar/yen exchange rate. The result: A 32 percent decline in the yen in less than 2½ years.

And that’s precisely what took shape in 1995, when the yen marked the all-time highs against the dollar, a level that held until this past week. The BOJ, along with the Fed stepped in to stop a steady, and steep, five-year slide in the dollar/rise in the yen.

It worked.

The yen fell 46 percent against the dollar over the next three years … and in the process marked a high in the yen that stood for sixteen years.

Why Japan’s Intervention
Will Work this Time, Too

Every major turning point in the past 16 years (with only one exception) has come with a BOJ intervention. But looking back at history, every episode of intervention hasn’t meant a turning point for the yen. So many in the foreign exchange market believe yesterday’s effort will fail — and ultimately a strong yen will win out.

I disagree …

First, Japan desperately needs a weaker yen.

Even before the events of the past week, I can’t think of one fundamental argument that would support the case for a stronger yen.

Second, Japan has every incentive to keep intervening.

Remember, this is a country attempting to weaken its currency, not save it from a death spiral of weakness.

Given that fact, currency market intervention by Japan works in their favor in several ways …

It softens the currency burden for its all-important exporters; thus making their products more competitive in the world market. And it requires Japan to print more and more yen, ultimately easing monetary policy even further. Indeed, a move needed in Japan’s fight against persistent deflation.

So what do they do with all of the freshly printed yen?

You can expect the BOJ to add more U.S. dollars to its reserves.

They sell it and buy U.S. dollars. That means they stockpile currency reserves … an area commonly perceived to be a gauge of a country’s financial wealth and stability.

Because of the incentives I discussed above, I expect Japan’s intervention efforts to persist and pay off. Perhaps most important though, is that its G-7 partners have its back this time around.

Japan’s intervention could be just the first step in a long, sharp devaluation of the yen. And given the recent weight the strong yen has placed on the dollar, don’t be surprised if the turn in the yen also results in a broad dollar rally.

For currency traders, this creates a tremendous opportunity to go along for the ride. And with the advent of exchange traded funds (ETFs) and options that track global currencies, the opportunity for individual investors to take part has never been easier.

To see how you can receive concise instructions on using ETFs and options to get the biggest possible payoff from fluctuations in the yen, the dollar and other world currencies, click here to view my latest presentation.

Regards,

Bryan