Friday, March 12, 2010

Gotta catch 'em all!

Prime Minister Hatoyama announced today that the yen is too strong and said that the exchange rate should be left to the markets...

But, of course the value of the yen should be left to markets! That's the whole point of a floating exchange rate. So why the announcement and why is it a headline in the Financial Times?

Well, this is sort of like when a passive aggressive friend tells you, "I can't decide for you if you should come to my party, you must make the right decision for yourself." Oh, and now imagine that your friend adds, "I wouldn't hold it against you except in extreme circumstances..."

For, the FT article goes on to say that PM Hatoyama added that markets should determine the exchange rate, "except in cases where there were sudden moves in the market that did not reflect the fundamental value of the currency" [quoting FT, not PM Hatoyama].

Basically, the Prime Minister is throwing a little uncertainty out to markets about what the government might do. And considering that his party's sweeping electoral victory last year represented an historic shift in power in Japanese politics, there isn't much track record to judge.

Now, the announcement is unlikely to shatter markets - the FT reports that the yen only weakened slightly following the Prime Minister's comments. And the government will likely not take any real action to lower the value of the yen.

Still, the announcement itself is a li'l bit of an action. The government does not want to see the value of the yen appreciate. A weak yen would be good for the strong export-oriented sector in Japan. A dropping yen would do much more to help Toyota sales, for example, than any further appearances from Mr. Toyota himself. The weak yen would make Japanese automobiles, electronics, etc. cheaper for people abroad (e.g., Americans), and it would make imports more expensive for Japanese consumers.

Let's take a broader perspective: The financial crisis in 2008 weakens the dollar. The Chinese renmimbi is pegged mostly to the dollar, so its value drops. In relative terms, this makes the euro and the yen stronger... Now, with the Greek tragedy playing out, the value of the euro drops. So, investors (and speculators) are looking to see what currency will keep its value... And, by the way, if we all coordinate on buying the same currency, we'll have a self-fulfilling prophecy. The value of whichever currency we all coordinate on will rise accordingly.

So, Prime Minister Hatoyama's headline is really just a message: the buck does not stop here either!

Now, under the old days that led up to the Great Depression, governments had fixed exchange rates and played dirtier. They engaged in outright competitive devaluations, and this beggar-thy-neighbor approach caused things to spiral out of control. A weakened currency can boost an economy, a valueless currency not so much. With major currencies on floating exchange rates, movements are gradual, and the games that governments play are subtle. That's good for all of us.

Yet, if we don't trust the dollar to rise, and we don't trust the euro to rise, and we don't trust the yen to rise, and the currencies of the emerging markets are still a bit risky, where will we go? The Chinese and the IMF have been floating the idea of a new international reserve currency... but I'm not optimistic. Does anyone know the number of a gold-broker?

For more on the coordination around international reserve currencies see:
McNamara, Kathleen R. 2008. A rivalry in the making? The Euro and international monetary power. International Political Economy 15 (3):439-459.

And for a great intro to these topics, see:
Oatley, Thomas. 2010. International Political Economy (4th Edition) (Paperback). New York: Longman.


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