At best, the G7 currency intervention will postpone the inevitable adjustment of world currencies to a change in demand for yen. At worst, the Bank of Japan can enforce a permanent depreciation through money creation, which will redistribute wealth.
FULL ARTICLE by Robert P. Murphy
{ 25 comments }
This article makes an excellent defense for speculators. If the rapid appreciation of the Yen was due to speculators *moving their own money to Japan* BEFORE the bulk of charity donations could arrive, and before japanese insurers’ large illiquid assets could be sold, then it is the speculators’ actions which had the most immediate relief effect. As a result of the speculators’ actions, every single person in Japan that had even a single Yen to their name became slightly wealthier, almost immediately. Of course the charity money that arrives later is a necessary piece of the puzzle too, but I like the fact that the aim of charitable giving – to get as much purchasing power into the hands of the relief agencies as quickly as possible – is achieved much faster if speculators are allowed to act freely.
The speculators are just placing their bets on the expected behavior of individuals. That is in the immediate aftermath of a disaster the people in the disaster will stop buying normal stuff and either store money, or as you said liquidate foreign investments or receive insurance payouts. Then individuals would begin buying rebuilding stuff. This is natural.
What is in my mind insane is that the Government of Japan and its toy, the Bank of Japan would attempt to fight rational and natural behavior. Their actions are taking real savings out of the hands of insurers paying off claims, localities and companies attempting to restart/rebuild infrastructure and individuals dipping into their savings for rebuilding materials, and instead giving this money to exporters to keep their market share by making exporter prices to the USA and other foreign buyers seem cheaper. So as a person in the USA who buys Japanese stuff, I say thanks to the BOJ.
Also, when Japan does start buying those Dollars to buy US goods, the Yen value will plummet even further than it’s pre-quake levels. The BoJ will end up with a far weaker Yen because of this.
I loved this quote: “Many people were surprised that the yen would strengthen following a natural disaster that disrupted the Japanese economy, but we should remember that a currency is not really a proxy for a country’s economy. No, the price of the yen is set by supply and demand in the currency markets.”
I think the above also explains why the US dollar strengthened in 2008 when it should have actually weakened from a rational perspective.
When there’s a stock-market crash, people with assets will prefer money over investment assets, increasing the demand for money.
Investors call this behaviour “flight to quality”
And also perhaps as “flight to Liquidity”.
http://ideas.repec.org/p/nbr/nberwo/10327.html
http://www.nber.org/papers/w12376
http://en.wikipedia.org/wiki/Flight-to-liquidity
http://en.wikipedia.org/wiki/Flight-to-quality
WIKI:
Another excellent article, Robert. When the yen rose after the quake, I wondered if part of the reason was that people in Japan were reacting to uncertainty by increasing their demand for money balances. Unless the Bank of Japan accomodated this increased demand for liquidity, loans would be called in and the money supply would fall. Higher demand and lower supply would lead to a rise in the price of money. What say you?
Most of the yen supply isn’t in Japan; in fact, mass repatriation is BoJ’s worst nightmare.
I don’t see how that’s possible considering Japan is a net exporter.
The carry trade perhaps? Short yen, buy assets.
Actually the carry trade’s unwind had a big role to play in the recent correction, I’d wager. A significant proportion of investors sold the market and converted to yen.
Why wouldn’t the charitable dollars coming in from around the world, converted to yen eventually, have the same currency-weakening effects as the central bank printing money out of thin air? I would think that locally, in the short term, the effects would be the same. In the long-term, printing is probably worse because the money supply has been increased. I guess Mr. Murphy eluded to this by implying that sending capital goods versus money is superior.
It wouldn’t have the currency weakening effect unless the supply of yen increased. Otherwise the only effect would be to increase the price of yen in other currencies, driving up the value of the yen.
If people want more gold (increase demand), and the supply is constant the price will increase. The price would never go down due to more people buying gold. The price would only go down due to an increase in the supply of gold, or due to people who were formerly buying gold selling it. In this case, that’s what Murphy is talking about with the Japanese spending yen on foreign products. This will drive the value of the yen back down, but only after they receive extra goods that they wouldn’t have received without the donations.
How is the supply of yen not increasing on a local, short-term scale? Those affected the worst would presumably get most of the “new” money, and they would spend it to rebuild. Those not as bad off, or relatively unscathed, would get less aid yen (or none), but would have to deal with local higher prices on everything. I’m not saying that all charity has negative consequences, but most people give blindly without considering the economics on the ground.
This analysis leaves me with the feeling that things are much more complex than presented. For example, you could make case that if BOJ does nothing donor contribution value is lowered due to the action of the market. Since the value of yen rises before the charitable money arrives less yen can be purchased with that money. If the market also anticipates the spending of that money then the value of the yen will drop before it can be spent and the charitable contribution loses on both sides of the transaction into and out of yen.
It is also interesting to imagine what the effect would be in a hard money situation. As the charitable gold pours into Japan wouldn’t that increase local prices and thus hurt the non-receivers of the giving? But then that would also lower the prices outside of Japan as the external gold supply falls by the same amount. My brain hurts.
Re: Charitable donations under hard money:
If we take into account the loss of supply of capital and goods from the tsunami, plus the influx of donated money we’d expect to see a general rise in prices. Luckily for us entrepreneurs use prices to help them identify areas of market demand and higher prices make it more appealing to enter the market, which is exactly what a country in the process of rebuilding itself needs; a strong incentive to produce!
How does this not result in malinvestment and boom-bust cycles? Classic Austrian economics at work – money pouring in, some of it will be malinvested.
But in this case it would be “real” money, representing actual capital, that would move into Japan. US donors would forgo capital purchases by donating money, and Japanese recipients would then be able to purchase capital goods from the US.
Malinvestments (in the ABCT sense) are the result of printed money driving up the costs of capital goods… printed money can’t improve welfare because there are no real capital goods to back it up.
I agree with you Bruce.
In reading the posts and the article I also made the same connection you did.
Namely between (1) and (2) below.
BETWEEN (1) The speculation-driven (earlier-than-otherwise-would-be-the case) RISE in the relative value of the YEN to (say) the dollar (even BEFORE foreign contributions start being received in Japan and/or before the Japanese themselves start to repatriate some of their foreign-currency investments from offshore, in order to use those monies to rebuild).
AND (2) The fact that as a result (of the action of the early-speculators) these foreign donations would buy LESS YEN-money in Japan than would otherwise be the case. So this would create more hurt to the Japanese who need this money because now the speculators have made money from what otherwise would have been an exchange driven only by the monies donated (and the monies that the Japanese themselves were repatriating for their own needs from their foreign-currency holdings).
But in looking at the analysis of yours and mine (above) I started thinking that even though the donated foreign money would buy less YEN-money than otherwise would be the case, at THAT POINT IN TIME, at the MARGIN, IF IT WERE THE CASE THAT those same smaller amounts of YEN could be used to buy foreign goods, it might not really matter — because for THAT last dollar that was donated (and converted into YEN), it could be in principle be converted back to the same dollar (less transaction costs) with which to buy foreign goods.
Your point about using donor-dollars to buy local goods in Japan with the YEN that they were converted into is valid — there indeed are less YEN being realized by the donees if the YEN has already been driven up in relative value by the always-vigilant speculators.
So it kind of depends on where the donated monies are going to be spent and how.
Perhaps the lesson is that the donated money should not be converted by the receiving agencies at all, EVER and should simply be used to buy goods from the source-countries as alluded to by Robert Murphy. As one post suggested, just use that foreign money to buy capital goods from the home countries of the donors.
That way, the donor-countries actually do help Japan, and with no conversion there should be no effect on the exchange rate between donor-country (say, America) and donee-country (Japan). Furthermore there would be no further additional rise in the relative value of the YEN, aside from that which had already been created by the “speculators”. And by not spending the received money on Japanese goods (which would presumably require the conversion to YEN) the agencies should realize more value from their humanitarian spending.
Their non-spending on Japanese goods should keep prices in that country somewhat lower than if they simply spent all that money in Japan on Japanese goods. And given that all the money is never converted (under this approach), and is instead spent offshore, presumably the speculators would have to start unwinding the positions they had prematurely taken in the YEN, because now there would be no mechanism to drive up the relative exchange rate between the YEN and (in this example) the dollar.
Under such a scenario, the Japanese agencies would be realizing probably more value for the monies they had received as donations. There would be less ‘need’ for the BOJ (Bank of Japan) to intervene. The market would take care of any adjustments.
In fact, let’s look at why such a scenario might actually occur naturally. If you are the guy or gal running an agency in Japan to help the folks who need help, and you look at all the numbers, you might yourself come to the conclusion that it does not make sense to convert all your money into YEN, even if the goods and services you need to help people with are available inside Japan. You might do the calculations, and discover, hey I will lose if I convert and buy inside Japan — instead I will do better for the victims if I do not covert and if I spend the dollars outside of Japan.
But regardless, the market will take care of itself. No central bank can micromanage and decide that it is helping a country like Japan MORE in relative terms by artificially LOWERING the value of the YEN versus other external currencies. That central bank may actually now be doing great harm as the YEN it has artificially lowered buys FAR LESS for the victims with the donated money — at least if it is converted back to foreign currency again for buying offshore. And perhaps if lowered enough in value, those YEN might create price inflation at home. [An aside, when people talk of there being no price inflation, they forget that in the absence of central bank creation of net-new money, there could well be price deflation, which in an Austrian view, is not to be feared like the poor trembling Bernanke fears it --- in fact, there indeed could be no CPI-measured price inflation as someone like Bernanke inflates the money supply, but that is not the pertinent measure; instead the pertinent measure is what would the price behavior have been in the ABSENCE of that central bank intervention.]
Firstly the fact that the spenders inside Japan in YEN terms will get less bang for the YEN, as already pointed out by the article and other posts. And secondly is the issue of trying to “help” exporters because presumably they are more important to the overall health of Japan as compared to the short-term need of the victims of the tragic natural disaster that Japan has had to endure.
This objective of the BOJ is of course to enable Japan’s exporters to not be harmed during any temporary rise in the value of the YEN, but that view is based IMHO on their faulty judgment.
IMO this is shortsighted and is completely driven by a maniacal and weird view of how Japan should operate — the old “TOP-DOWN” approach to Central Economic Planning, which is really harmful to Japan in the long run.
Trying to artificially design the Entire Economy to operate in one way or another is actually kind of stupid. This “export-oriented” Economic System Design-approach was seen to have been behind the Japanese Miracle, and later the Singapore Miracle, and the Taiwan and South Korean “miracles”.
Now it is China’s turn. The problem is that how many countries in this world can all operate on this model and for how long? Besides that, what is the point of making things and selling them on the world market in return for building up what essentially amounts to mounds of Paper Fiat Money? Really, it makes no sense at all, because that money is only worth the paper it is printed on, ultimately. Who knows what it will be worth when the holder tries to spend it?
Of course this system could not naturally occur if it were based on something similar to a gold-based system with its inherent feedback and reset mechanisms. It can only occur with the artificial system created by governments and their fiat (paper) currencies and their mandated central planning agencies known collectively as central banks and as The FED in America.
We should also remember that most of the speculators we are talking about may not be taking a position in the YEN to make money. They might MOSTLY instead be trying to NOT LOSE MONEY. I say this because there is an awful lot of Japanese money still in the infamous Carry-Trade enabled and abetted by the BOJ and by The FED among other central banks. That money is invested offshore from Japan in things like Treasury Bonds to realize a rate of return far higher in those investments than you can make on Japanese Government bonds. So why not borrow at basically ZERO percent and get a risk-free (or so they thought) return offshore? So at the first moment that there is any hint of the YEN shooting up, such investors must cover their positions — they are very much like short-sellers who panic in a short-squeeze type situation.
We should also remember that phony mechanisms like this one are created by The FED and others for the pure purpose of making the Rich Class much more rich, at the expense of the rest of us, who do not have access to such finagling, or who choose for moral reasons to not engage in such practices.
Perhaps you are right, again if the gold is spent only locally. But notice that a country that enforces “buy-at-home” policies (to beggar its neighbor) is really shooting itself in the foot. So long as the market is allowed to operate, and people are allowed to make buying decisions in the absence of government fiat and in the absence of central bank interference, the economic decisions are likely to be the ones that have the most utility to both buyer and seller. Again in your scenario, you are suggesting that the gold will be used locally (and it well might, if the “rulers” have anything to do about it) but the individuals making those economic decisions might well buy from offshore, since that might be the most logical thing to do (barring the heavy hand of interference, again).
Perhaps we ought to come up with a term that suggests the opposite of Adam Smith’s “Invisible Hand” and call it the “Visible Hand of Maladjustment” (I think you can come with something a little more elegant !!!)
Cheers.
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Anybody else see this article about how the organized crime group Yakuza are helping keep peace and order in Japan, in addition to providing supplies to victims of the disaster?
http://www.thedailybeast.com/blogs-and-stories/2011-03-18/japanese-yakuza-aid-earthquake-relief-efforts/
Great article.
I know you were saying that; even if ‘promoting stability’ were a goal, it wouldn’t be achieved by their methods. But why should ‘promoting stability’ be a goal in the first place? Perverting the sanctity of private property for the sake of an arbitrary goal is – of course – contradictory to people’s implicitly endorsed values.
I have this theory about central bank balance sheet expansions and their ‘effectiveness’ (i.e. the degree to which they debauch their currency). I say that – for a currency to be a viable and functioning currency – there has to be a profit-motive in owning it. Markets are always engaged in finding such a profit-motive. During periods of high inflation fears, the market tends to put fiat currencies at heavy discounts to par (i.e. a relatively small proportion of a central bank’s assets would have to be given up in order to acquire their liabilities (dollars, yen,…)). Conversely, during fear and panic, fiat currencies trade at small discounts from par (i.e. a relatively large proportion of a central bank’s assets would have to be given up in order to acquire their liabilities (dollars,yen,…)).
During inflation panics, fiat currencies tend to be debauched (by balance sheet expansions) with greater intensity, and during deflation/’risk-off’ panics; fiat currencies tend to be debauched (by balance sheet expansions) with lesser intensity. So, my conclusion for the recent Yen intervention is that the market will win (Yen goes up for a while): the BoJ & co. will come up with enormous nominal amounts to intervene with – and yet find that they’re powerless as they end-up increasing the assets backing the Yen by a broadly similar amount to the amount of printed Yen. This is because the fear-trade has already taken hold – they’re now ‘pushing on a string’.
Murphy,
This is a very disappointing article.
Under a global monetary standard (e.g. the gold standard) – which would imply fixed exchange rates – the gold-backed yen would not appreciate but be fixed relative to other currencies. The price of the yen would thus be barely affected by natural disasters.
However, under a regime of floating exchange rates – the price of the yen would vary according to supply-and-demand. The dynamics are thus vastly different as compared to a regime of fixed exchange rates.
As for recent events – the value of the yen appreciated as speculators expected demand for the yen to increase in the short-term due to repatriation of Japanese assets. In the medium to long run however, the yen is expected to decrease in value due to various economic difficulties (not least the recent spate of disasters).
The Bank of Japan and the G7 can thus be seen as smoothing the volatility and ‘correcting’ the value of the yen. Intervention in this case is justified. In fact, your article’s argument rests on one single premise – that speculators always reduce ‘volatility’ – and this premise is dubious in this case.
One can also dwell on the ethics of whether currency speculation of the yen under these circumstances is morally justified. To use an analogy – it’s almost akin to speculators buying up all the mineral water after the disasters happened, and then reselling them to the needy Japanese at a higher price. But I came here to make an economic not a moral point.
Could one not make the case that the resulting strengthening of the yen as a result of speculator’s market actions allow Japan-based firms already on the ground to afford much needed imports, thus making imported goods cheaper (then before) then local goods, and allowing wiggle room for incoming donations/insurance payments (from foreign holdings liquidations) to buy the cheaper goods even though they are getting less yen for their currency (once again, resulting from speculator’s actions)? So converting all those foreign currencies to yen (even at a “higher-priced” yen) would be justified if they were spent mainly on firms buying relevant imports (food, supplies for rebuilding, etc). I would also be curious as to how local firms (and prices) would react to other local firms selling much needed (and potentially better quality) imports at prices much more affordable then before the strengthening of the yen.
To Concerned Friend, I think you make a good point. JOHN has missed that fact, that the Japanese can, at least for awhile, buy MORE from offshore to help their stricken people, thanks to the “speculators” having driven up the value of the YEN. John forgets that buying YEN on “speculation” is not the same as buying up all the water etc. needed by the victims.
Either way, even if the donors who send their marks, dollars, and pounds, etc. to Japan to help in the relief efforts, have their own currencies converted into a slightly smaller pile of YEN than would otherwise have been the case (without the speculators) we can be assured that those donations together with the YEN money that the Japanese themselves will deploy to help their people, more resources will have been put to work than otherwise — that is, than if no donations at all had been made and if the “speculators” had not gotten involved.
As to your question about
I personally think that the relative need and demand for all kinds of supplies and services will be so high for quite a while, so that there will not likely be any reduction in prices for such needs and materials.
In other words, the local demands will increase MORE than necessary to keep prices at least as high as before the disaster, and possibly even drive them higher, due to shortages relative to what the demand/supply price-metrics indicated prior to the disaster.
Japanese authorities intervened in the markets to make the yen fall. One tool they use is cutting interest rates. Low interest rates discourage people from storing their money in yen and encourage them to save their money in other currencies with higher interest rates.
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