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Originally posted by Turq1
Doesn't that mean the Yen is gaining value?
Looks like it went from about 81 Yen to the dollar to 77.
Not sure if I can give you a brief summary, but I will give it a shot.
1. Japan is, by and large, an export economy.
2. An export economy sells more products when it's currency is weak, because those products are relatively cheap in the countries it exports to (due to exchange rate purchasing power).
3. As export economies mature, their currency tends to appreciate, but in Japan's case, the BoJ intervened and began a program of purchasing US treasuries to strengthen the dollar and weaken the Yen, and lowering the Japanese primary rate (bonds, overnight cash).
4. This led to a credit bubble/real estate bubble which ridiculously indebted everyone in Japan.
5. As a consequence of (4) BoJ lending to the domestic market came to a virtual halt, but given the low interest rates, foreign lending increased (particularly to US, Eur and AU). This is known as the carry trade. Borrow short in Yen, lend long in local currency.
6. The FX risk of the carry trade (5) is only lightly hedged, given the traditional stability of the BoJ and Yen interest rates (most common hedge are FX swaps). As a result, carry trade books have significant exposure to Yen, which traditionally has not been a problem, given previously mentioned stability of the BoJ.
7. The stability of the BoJ is now challenged, given that they now need to (a) calm financial markets with liquidity injections (b) will need Yen for re-building 40,000 homes and (c) they have a massive nuclear plant that may go critical soon which would be a cluster# of biblical proportions. Consequently, the BoJs ability to weaken the Yen by purchasing UST is now severely compromised, and so it is likely that (1) the undervalued Yen will appreciate to the market price and (2) the BoJ will need to sell UST to pay for (a,b and c) above. Hence, those carry traders who are exposed to Yen are borked (like the f*ckwit AU banks). Those who are exposed to Yen hedges (FX derivatives, options, forwards, futures, swaps etc) are either in the money or borked. But here is the real kicker: The FX market is a 24hr, 7 day per week, interbank market. It never closes. In fact, to close the FX market, even for 1 day would be a greater financial catastrophe than banks blowing up due to FX exposure to Yen. So now we have the perfect black swan event
Traders already spooked by Mideast unrest and today's bad housing data are worried that Japanese insurers and investors will redeem their assets overseas--essentially converting that money to yen--to pay for damages stemming from radiation leaks at Japanese nuclear plants, Bloomberg explains. There is also concern that Japanese investors, alarmed by the crisis in their country, will pull out of risky investments abroad. A currency strategist tells The Wall Street Journal that during times of trouble, investors also tend to purchase "safe-haven" currencies like the Swiss franc and the yen, which is considered safe because Japan is a net creditor to the rest of the world. "It may seem counterintuitive, since this is something happening in Japan, so naturally one might think the yen would weaken," he says.