Insight: Troubling truths behind the yen
By Jim O’Neill
Published: August 5 2009 15:54 | Last updated: August 5 2009 15:54
Should the Japanese yen have a hundred in front of its current 95 to the
dollar?
Since the global credit crunch started, the financial markets have
become even more accustomed to treating the yen as a haven, buying it as
a liquid hedge along with US Treasury bills (and Swiss francs) when all
else goes wrong. As we reach the second anniversary of the start of the
panic phases of the credit crisis, not only is there growing evidence we
are through the worst but it seems as though markets have lost sight of
the underlying issues involving the yen.
EDITOR’S CHOICE
Insight: Taking away the punchbowl - Aug-04Short View: Inventory cycle -
Aug-04Lex: US dollar - Aug-04Loonie in demand as greenback sags - Aug-
04On this day two years ago, $/yen traded at about Y118, more than 20
per cent more than it does today. The current level of the yen may not
seem so strange if you reflect on where some other financial assets were
priced that day. The S&P 500, for example, closed at about 1,467, close
to 40 per cent higher than today. Gold traded at about $670 per ounce.
To cite just those two, the yen may even seem cheap, but let’s look
more closely.
In terms of systematic financial risks, we maintain an index we call the
GS financial stress index. After creeping higher in the early summer
months, the GS-FSI started to deteriorate significantly at about the
time, two years ago, when money market funds started to become
dysfunctional, then exploded higher on the back of the Lehman failure
last autumn. Pleasingly, the index is now back down to where it would
have been in May 2007, suggesting that, as a result of aggressive
policymaker actions, the systematic risk appears to have been curtailed.
If so, why is the yen still so strong?
A glance at some underlying fundamentals for the yen, which have
deteriorated throughout this process, add validity to this question. The
past US trade report showed the US trade deficit with Japan fell to $1.
9bn in May, the lowest since February 1984. That month, $/yen traded in
a Y232-Y235 range. For much of my career, while the $/Deutschemark and
subsequently $/euro relationship always reflected more of a “financial
flavour”, $/yen was usually driven by trade-related flows. If that is
still the case, the yen deserves to be nowhere near where it currently
trades.
Let’s look deeper. Japan no longer runs much of an overall trade or
current account surplus. Indeed, exaggerated by the collapse of their
exports during the crisis, Japan has run some deficits in recent months.
Owing to the recovery of world trade, Japan is in the process of
shifting back into a small surplus, but below it there are some powerful
dynamics. If you exclude the trade position involving cars, Japan has
run a deficit, anywhere close to zero to 2 per cent of gross domestic
product for the past 18 months. Given Japanese automakers’ ability to m
ove  production closer to their markets, at current exchange rate levels
producing elsewhere around the world would seem surely more attractive
(China for the Chinese market, the UK for Europe, and so on). If this
trend continues, the main thing that has kept Japan in a small overall
trade surplus over the past 18 months, and has been behind its huge
surpluses for three decades or more, will slowly disappear.
Delving deeper into the structure of Japan’s balance of payments, its
savings behaviour, and of course its fiscal dynamics, things become even
clearer. In the mid- to late 1990s, it was popular to argue that the yen
should weaken sharply. The arguments were 10 years too early. Those of
us who looked at Japan’s balance of payments closely, doubted this
popular view. Perhaps the view of the mid 1990s needs to be resurrected.
Japan’s much vaunted household savings rate has continuously slowed and
is now a paltry 2 per cent, while rapidly delevering and cleansing US
households have raised theirs to 4.6 per cent. Yes, current data tell us
US households are saving more than double those in Japan.
Of what is saved by Mrs Watanabe et al, much is seeping into foreign
investments. High-yield US bonds denominated in Brazilian real or
Turkish lira are the housewife’s choice du jour, as I found out on a
recent trip. On the back of this, there has been a steady net outflow in
terms of overall portfolio flows of bonds and stocks. As a result, Japan
is running a large so-called “broad basic” balance of payments deficit,
the combination of the current account, net foreign direct investment
and net portfolio flows. In fact, on the basis of the past 12 months, it
is a deficit of close to 6 per cent of Japan’s GDP, more than double
that of the US.
So when we all worry about how to finance burgeoning debt bills, is it
really the likes of the US and UK on which we should focus? According to
our estimates, Japan’s general government debt-to-GDP ratio may rise
above 200 per cent next year, more than double that of any other
developed country. With domestic household savings now below the US, it
looks as if Japan will have to attract a lot of foreign capital at some
stage. Should the yen not be closer to Y195 than Y95?
The writer is chief economist, Goldman Sachs
By Jim O’Neill
Published: August 5 2009 15:54 | Last updated: August 5 2009 15:54
Should the Japanese yen have a hundred in front of its current 95 to the
dollar?
Since the global credit crunch started, the financial markets have
become even more accustomed to treating the yen as a haven, buying it as
a liquid hedge along with US Treasury bills (and Swiss francs) when all
else goes wrong. As we reach the second anniversary of the start of the
panic phases of the credit crisis, not only is there growing evidence we
are through the worst but it seems as though markets have lost sight of
the underlying issues involving the yen.
EDITOR’S CHOICE
Insight: Taking away the punchbowl - Aug-04Short View: Inventory cycle -
Aug-04Lex: US dollar - Aug-04Loonie in demand as greenback sags - Aug-
04On this day two years ago, $/yen traded at about Y118, more than 20
per cent more than it does today. The current level of the yen may not
seem so strange if you reflect on where some other financial assets were
priced that day. The S&P 500, for example, closed at about 1,467, close
to 40 per cent higher than today. Gold traded at about $670 per ounce.
To cite just those two, the yen may even seem cheap, but let’s look
more closely.
In terms of systematic financial risks, we maintain an index we call the
GS financial stress index. After creeping higher in the early summer
months, the GS-FSI started to deteriorate significantly at about the
time, two years ago, when money market funds started to become
dysfunctional, then exploded higher on the back of the Lehman failure
last autumn. Pleasingly, the index is now back down to where it would
have been in May 2007, suggesting that, as a result of aggressive
policymaker actions, the systematic risk appears to have been curtailed.
If so, why is the yen still so strong?
A glance at some underlying fundamentals for the yen, which have
deteriorated throughout this process, add validity to this question. The
past US trade report showed the US trade deficit with Japan fell to $1.
9bn in May, the lowest since February 1984. That month, $/yen traded in
a Y232-Y235 range. For much of my career, while the $/Deutschemark and
subsequently $/euro relationship always reflected more of a “financial
flavour”, $/yen was usually driven by trade-related flows. If that is
still the case, the yen deserves to be nowhere near where it currently
trades.
Let’s look deeper. Japan no longer runs much of an overall trade or
current account surplus. Indeed, exaggerated by the collapse of their
exports during the crisis, Japan has run some deficits in recent months.
Owing to the recovery of world trade, Japan is in the process of
shifting back into a small surplus, but below it there are some powerful
dynamics. If you exclude the trade position involving cars, Japan has
run a deficit, anywhere close to zero to 2 per cent of gross domestic
product for the past 18 months. Given Japanese automakers’ ability to m
ove  production closer to their markets, at current exchange rate levels
producing elsewhere around the world would seem surely more attractive
(China for the Chinese market, the UK for Europe, and so on). If this
trend continues, the main thing that has kept Japan in a small overall
trade surplus over the past 18 months, and has been behind its huge
surpluses for three decades or more, will slowly disappear.
Delving deeper into the structure of Japan’s balance of payments, its
savings behaviour, and of course its fiscal dynamics, things become even
clearer. In the mid- to late 1990s, it was popular to argue that the yen
should weaken sharply. The arguments were 10 years too early. Those of
us who looked at Japan’s balance of payments closely, doubted this
popular view. Perhaps the view of the mid 1990s needs to be resurrected.
Japan’s much vaunted household savings rate has continuously slowed and
is now a paltry 2 per cent, while rapidly delevering and cleansing US
households have raised theirs to 4.6 per cent. Yes, current data tell us
US households are saving more than double those in Japan.
Of what is saved by Mrs Watanabe et al, much is seeping into foreign
investments. High-yield US bonds denominated in Brazilian real or
Turkish lira are the housewife’s choice du jour, as I found out on a
recent trip. On the back of this, there has been a steady net outflow in
terms of overall portfolio flows of bonds and stocks. As a result, Japan
is running a large so-called “broad basic” balance of payments deficit,
the combination of the current account, net foreign direct investment
and net portfolio flows. In fact, on the basis of the past 12 months, it
is a deficit of close to 6 per cent of Japan’s GDP, more than double
that of the US.
So when we all worry about how to finance burgeoning debt bills, is it
really the likes of the US and UK on which we should focus? According to
our estimates, Japan’s general government debt-to-GDP ratio may rise
above 200 per cent next year, more than double that of any other
developed country. With domestic household savings now below the US, it
looks as if Japan will have to attract a lot of foreign capital at some
stage. Should the yen not be closer to Y195 than Y95?
The writer is chief economist, Goldman Sachs
