No. 3 — January 21, 2000

 

Weekly Review

YEN'S RALLY CONTINUED IN 1999
--- by Douglas Ostrom

Last year, the yen averaged ¥113.9=$1.00, a gain of 14.9 percent from its 1998 average (see Table 1). If history is any guide, this surge, which began in September 1998, has not yet run its course. Momentum may carry the yen higher for months, even years. Japan's currency rose against the dollar in eight months of 1999 in addition to increasing for four straight months in finishing 1998. The yen's 1999 yearend value was only slightly weaker than the year's high of ¥101.3=$1.00 recorded the day before.

Table 1: Yen-Dollar Exchange Rate, 1994-99

(monthly average, Tokyo interbank market)

1994

1995

1996

1997

1998

1999

January

¥111.5

¥99.8

¥105.8

¥118.0

¥129.5

¥113.2

February

106.2

98.2

105.7

123.0

126.0

116.7

March

105.1

90.8

105.9

122.6

128.7

119.8

April

103.5

83.7

107.5

125.5

131.7

119.8

May

104.0

85.1

106.5

119.0

135.0

122.1

June

102.7

84.5

108.9

114.2

140.6

120.9

July

98.5

87.2

109.3

115.2

140.7

119.9

August

99.9

94.6

107.8

117.9

144.7

113.4

September

98.8

100.5

109.7

120.8

134.6

107.6

October

98.4

100.7

112.4

121.1

121.3

106.0

November

98.0

101.9

112.3

125.3

120.6

105.0

December

100.1

101.9

113.8

129.5

117.5

102.7

Annual Average

102.2

94.1

108.8

121.0

130.9

113.9

 

The yen's run-up in value through most of 1999 reversed three consecutive years of lost ground. Before that, it had appreciated in each of five successive years beginning with 1991. A strictly mechanical application of recent patterns suggests that during the current phase, the yen will exceed the postwar high of slightly more than ¥80=$1.00 that it achieved briefly in the spring of 1995.

Many analysts believe that the yen's recent strength against the dollar is a major risk factor for the Japanese economy. They add that further appreciation of the currency would render exports uncompetitive and encourage imports; both effects would tend to suppress aggregate demand and make an economic recovery more difficult.

This line of thinking almost certainly will be voiced at the January 22 meeting in Tokyo of the finance ministers and central bankers of the Group of Seven industrial nations. In fact, Japan intervened several times in foreign exchange markets in late December and in early January in an effort, at least temporarily successful, to prevent the yen from cracking the ¥100=$1.00 barrier. At a minimum, the government of Prime Minister Keizo Obuchi would like to get rhetorical support from Japan's G-7 partners for a weaker yen. Japanese experts &emdash; among them Eisuke Sakakibara, the former Ministry of Finance official once known as "Mr. Yen" for his reputed ability to influence currency markets &emdash; are pushing for a strong G-7 statement that would discourage large bets on the yen.

By mid-January, the Japanese currency had slightly backed off from its recent highs, settling around ¥105=$1.00. This development apparently reflected the spillover effects of actions taken at yearend to deal with expected Y2K problems. Some analysts have speculated that significant movement in the yen/dollar exchange rate will depend on how currency traders read the outcome of the G-7 confab.

The long-term pattern evident in Table 1 raises the possibility of a cause-and-effect scenario quite different from the one assumed by Japanese policymakers. The yen's movement appears to reflect changing expectations for Japan's economy rather than to be the cause of them. Like the value of the Japanese currency, this thinking moves in the same direction for months at a time.

In this instance, a strong yen results from a belief that business investment or public-sector demand already has increased or is about to rise, triggering an upturn in net demand for the Japanese currency and a run-up in its value. For example, the yen's strongest period ever was in the spring and summer of 1995, a few months before the minirecovery of 1996 and early 1997. If a strong currency has the power to short-circuit a recovery, it should have been evident at that time. In contrast, the yen's weakness in 1989 and 1990 preceded the downturn that began in 1991.

A year ago, this theory seemed to have been discredited. The yen was strong and the economy weak &emdash; or so it was thought. Yet, the first quarter of 1999 turned out to be one of the best in recent decades, and it was followed by further growth in the April-June period. Admittedly, these two booming quarters were offset in part by the economy's weak July-September performance (see JEI Report No. 46B, December 10, 1999). On balance, though, optimism about Japan's economic prospects grew throughout the year, along with the value of the yen. Contrary to previous predictions, most analysts now estimate that the world's second-largest economy managed a modest increase in 1999.

The theory that the yen's value reflects, rather than causes, macroeconomic changes also is consistent with its movement in 1999 against currencies other than the dollar (see Table 2). If the yen moved independently of anticipated economic conditions in Japan, it might be expected to rise or fall against various currencies based on some combination of the economic performance of trading partners, the virtually random actions of speculators and the attempts of monetary authorities abroad to influence the yen's value. These factors, which differ in importance by country, would lead to widely divergent trends in the yen's value depending on the counterpart currency. Yet, in 1999, the yen appreciated across the board against nine major currencies and the euro, which was launched last January. Moreover, the extent of the yen's appreciation generally was comparable, except against the euro, which lost 22.9 percent of its value vis-a-vis the Japanese currency.

Table 2: Changes in the Yen Against Selected Currencies, 1998-99

(other currencies in terms of yen at yearend)

1998

1999

Change

German Deutsche mark/eruo*

¥68.0

¥52.5

-22.9%

British pound

188.3

165.0

-12.3

Australian dollar

69.5

66.7

-4.0

Canadian dollar

74.1

70.3

-5.2

South Korean won

0.094

0.09

-4.5

Singapore dollar

68.7

61.3

-10.7

Taiwan dollar

3.5

3.3

-7.7

Hong Kong dollar

14.6

13.1

-10.3

Thai baht

3.1

2.7

-12.2

U.S. dollar

113.5

102.1

-10.0

Trade-Weighted Average

-10.1

*From January 1, 1999, the Deutsche mark moved parallel to the euro, which closed December 31, 1999 at 101.2 yen per euro.

 

Table 2 suggests the emergence of three currency blocs centered around the euro, the dollar and the yen. European Union nations like France and Germany that have adopted the euro are members of one group. Their exchange rates are absolutely fixed within the bloc but highly variable vis-a-vis other currencies. The currencies of such Asian nations as Singapore, Taiwan and Thailand are more closely tied to the dollar than to the yen or to the euro. The fact that last year, these currencies and the dollar fluctuated by roughly comparable amounts against the yen implies little movement in their rates against the dollar or against each other. In other words, the preferences of some officials in Tokyo notwithstanding, several of Japan's key Asian trading partners remain in a de facto dollar bloc.

Among the listed countries, Japan would appear to be in a bloc of its own. This reality gives it few natural allies around the G-7 table. The world's leading economies, and even the Asian nations outside the G-7 process, see little risk in a strong yen since their own currencies are not closely linked to it. They may be sympathetic to the view that a rising yen is evidence that, at long last, the Japanese economy is on the road to recovery. In that sense, the yen's strength is a welcomed sign. If this signal brightens further in coming months, all the better.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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