Will Intervention Work?

In late trading on Wednesday, the yen went through the magical 80 yen/dollar barrier (125 in the reciprocal dollar/yen notation) and it did so with some verve. Rumors had been circulating previously that numerous stops and a bevy of options were tied to the 80 level and it showed when the 80 level was taken out – within minutes the yen was trading in the 76 region, an enormous move for such a brief period. Below is a chart isolating the move on Wednesday night  – not shown on this chart is the fact that after knocking out the stops and written options, the yen immediately pulled back again to the 79 level, its previous high reached in 1995.



The yen-dollar rate goes medieval on option sellers and yen shorts on Wednesday evening – click for higher resolution.



A daily reciprocal dollar-yen chart shows the enormous move in all its glory – when the old high fell, the yen shorts scrambled to cover – click for higher resolution.



The yen weekly chart over the past three years. This is evidently a classical bull market. No market technician would short such a chart – nonetheless, shorting the yen has been a major pastime of all sorts of traders over the past few years – click for higher resolution.




The market's recent yen for the yen has now finally jolted the interventionist brigade into action. Yesterday the G7 have issued a communique on the yen, promising 'concerted intervention' to bring it down. Once again, a big move occurred in thin overnight trading – this time in the other direction.



Last night – the yen gets the message that the G7 are going to gang up on it and yen-dollar goes back above the magical 80 level – click for higher resolution.



As Bloomberg reports:


“The G-7 said in its statement that “in response to recent movements in the exchange rate of the yen associated with the tragic events in Japan, and at the request of the Japanese authorities” it will intervene in the currency market today. “We will monitor exchange markets closely and will cooperate as appropriate,” the statement said.

Against the dollar, the yen fell 3.2 percent to 81.48 at 10:48 a.m. in London, compared with the postwar high of 76.25 reached yesterday. It slid 3.7 percent versus the euro to 114.91. The Nikkei 225 (NKY) rose 2.7 percent at the close.

Japan’s intervention today was its first since September, when it acted on its own after the yen had climbed to 82.88, the strongest at that time since 1995. The Bank of Japan sold 2 trillion yen in that effort, which was the first such move since 2004.

“We won’t manipulate it, but I hope that the yen goes back to where it was before the earthquake,” Vice Finance Minister Fumihiko Igarashi said in an interview today in Tokyo. He added that the government at the same time wants to avert any “abrupt weakening” in the currency. Because the aftermath of the earthquake has “hurt the economy and fiscal situation, it won’t be a surprise” if bond yields go up and the yen weakens. “That’s naturally the biggest fear for the government.”

The European Central Bank, Bank of England, Bank of France, Germany’s Bundesbank and the Italian central bank all said they’re participating in the yen sales today. The central bank of China, which isn’t a G-7 member and belongs to the larger Group of 20, didn’t respond to a request for comment on yen sales.”


What an odd thing to say – just after they manipulated the yen they state they don't want to manipulate it? However, the Japanese government's fears regarding the currency and bond markets are perhaps not entirely unfounded. Especially the bond market must worry it greatly. Although so far the JGB market has remained very strong, credit default swap spreads on JGB's have seen a huge spike higher – and that is often a precursor to bond market weakness.

No doubt the intervention  was motivated by the fact that – as rumor has it – the Japanese banks specifically would be hurting if the 80 level were to be taken out decisively. Apparently they are the big options writers. We want to stress that we can not independently confirm this fact, but it does have the ring of credibility. Japan's banks are in all likelihood the biggest players in the yen and the derivatives tied to it.

The move in the yen was precipitated by a huge overnight jump in Yen-LIBOR rates on Tuesday, which rose in response to fears over rising counter-party risk.

According to Reuters:

Benchmark Japanese yen interbank rates jumped by the most in a day on Tuesday, reflecting rising counterparty risks as a deepening nuclear crisis in quake-hit Japan fueled risk aversion globally.

Some analysts said they expected yen interbank rates to grind higher but at a slower pace after the Bank of Japan offered to pump 5 trillion yen ($61 billion) into the banking system on Tuesday.  This followed a record injection of 15 trillion yen in same-day market operations and eased monetary policy further to support the economy recover from a triple blow of a massive earthquake, tsunami and nuclear emergency.

While euro-yen futures  edged higher after the BoJ moves, three-month yen Libor  fixed up at 0.20000 percent from 0.19250 percent, its highest since mid-October.

"As the power situation deteriorated today, and stock markets tumbled, it should not be surprising that this is reflected in (yen) Libor rates as risk will have risen and counterparty risk will have increased as losses look to be rising," said David Rea, an economist at Capital Economics.

"The greater the risk, and the greater the perceived loss to the economy and by extension the financial system, the greater the pressure on Libor. The Bank of Japan can, and undoubtedly will, do what it can to ensure there is liquidity, but this will not remove risk."



The surge in overnight yen LIBOR on Tuesday – it has since then pulled back to 0.17375, which is still elevated but shows that the panic is receding for now – click for higher resolution.



The Dismal Record of Interventions

We would note to the G7 communique that it may be an indication that the yen's trend was ready to reverse anyway. By the time a currency move becomes so intense that the bureaucrats spring jointly into action, it often means that the trend was ready to reverse anyway. See e.g. the Plaza and Louvre accords on the US dollar, where joint intervention was decided upon to first stem a strong rise and then a strong fall in the dollar. By the time the Plaza accord was decided upon, the dollar had become so overbought and overvalued that it would have fallen anyway. The illusion that the intervention caused it to change its trend of course survives to this day.

In the case of the yen, the proposition that joint intervention can change its trend is even more preposterous. The dollar is used as the world's reserve currency, so every central bank actually has a sizable hoard of dollars it can sell. This is not the case with the yen – only the BoJ can be reasonably expected to sell yen in volumes that could make a difference, and the BoJ's historical record in yen intervention is a long litany of dismal failures.

The idea that governments are able to influence long term trends in financial markets is complete hokum, to put it bluntly. In fact, it is precisely the BoJ's dismal record that stands as incontrovertible proof of this contention, closely followed by the SNB's abysmal failure to stem a rise in the Swiss Franc against the euro last year.

If a central bank is unable to stem an increase in the value of the currency which it can theoretically issue in unlimited amounts, only one conclusion can be arrived at: the market is bigger than any government or congregation of governments.

If the yen's trend now changes, it won't be because the G7 want it to. It will happen because the market deems the yen to be overvalued. If the yen's bull market has further to go – an outcome that is actually strongly suggested by its chart – then no amount of intervention will be able to stop it from doing so.

Japan's Money Supply Growth – The True Driver of the Yen's Exchange Rate

Let us also remember here that Japan's money supply growth has been far lower than money supply growth in both the US and the euro area for many years. There has therefore been a strong fundamental underpinning to the yen's strength, further exacerbated by Japan's perennial trade surplus. Year-on-year growth of Japan's money TMS as of February stood at 3.3%, which is actually a recent high point in this growth rate.

Why is money supply growth so slow in Japan? There are in our opinion two major reasons for this.

One is the fact that Japan's private sector remains in 'deleveraging mode' in Japan's post-bubble era. Both corporations and individuals are still not willing to add leverage to their balance sheets after the enormous shock of the post-bubble credit collapse. At one point in the mid to late 1990's, Japanese bank credit growth was negative for 60 consecutive months.

The other reason is that the BoJ has been made independent – and the technocrats at the helm of the central bank are apparently very conservative and don't believe that much can be achieved by heavy monetary pumping. Not only did such attempts previously fail (Japan had two major iterations of 'quantitative easing' and is currently engaged in a more modest third one), but there are also other considerations playing a role.

For one thing, the Japanese government has been in a non-stop Keynesian deficit spending spree over the last two decades. It has been following the advice of a number of US economists, who urged Japan's government  to 'boost aggregate demand' by spending its head off. Naturally, this has had the exact opposite effect of that predicted by said economists – instead of boosting the economy, it has prolonged the slump. The Keynesians now maintain that Japan 'did not spend enough' or 'stopped spending at inopportune moments' and similar excuses, but the fact remains that Japan has followed their advice and has nothing to show for it except a huge mountain of government debt, amounting to over 200% of the country's GDP.

Due to being saddled with such an enormous debt load, the government can simply not afford to pay a high interest rate on its debt. Were the BoJ to pursue a highly inflationary policy, interest rates would likely rise sharply from their current extremely low levels, which in turn would render the government insolvent in short order. All that deficit spending has put the BoJ into a box. It forces it to pursue a relatively tight monetary policy  – which is actually a positive counterweight to the government's useless, never ending spending sprees.



Japan's soaring government debt since the beginning of the economic slump in 1990. Prominent Keynesians such as Joseph Stiglitz, Paul Krugman or Nomura's Richard Koo tend to claim that Japan 'did not spend enough' to rescue its economy from stagnation. If the above is these peoples' idea of 'not enough spending', we'd hate to see what they would consider a sufficient level of deficit spending. Of course deficit spending can only delay economic recovery. Economic actors in the private sector are after all footing the entire bill – the government does not possess a secret stash of resources it can marshal. The more the government spends, the less the private sector will spend and invest – click for higher resolution.



Another important factor in the BoJ's relatively conservative policy stance is what we would term its 'institutional memory'. The main monetary event of the past century that informs the thinking at the central bank is Japan's experience with hyperinflation immediately following World War II. Just as the brief but severe money supply deflation at the onset of the Great Depression is the overarching institutional memory that informs the Bernanke Fed, so does the Japanese hyperinflation of the post-war years influence the stance of the bureaucrats at the helm of the BoJ.



Data on Japan's true money supply , via Michael Pollaro. As can be seen here, Japan's money supply growth has been very tame, in spite of the near zero administered interest rate policy of the BoJ. The reason is that private sector credit growth remains extremely subdued in Japan's post-bubble era, and unless the BoJ goes on a major debt monetization spree, money supply growth will therefore remain very slow – click for higher resolution.




In the wake of the earthquake and the nuclear accident at the Fukushima Daiichi plant, it is of course possible that the BoJ's policy will undergo a dramatic change. It has already injected vast sums into the banking system to 'bolster liquidity' and 'ensure the smooth working of the payments system'. It has also reportedly bought up large amounts of REIT shares and other securities in recent days to arrest the slump in Japan's stock market.

Should the markets begin to suspect that this change in the BoJ's policy is not merely a temporary measure to stem the panic following the earthquake tragedy, but a more long-lasting shift in its approach to monetary pumping, the yen would surely begin to weaken of its own accord.

It remains to be seen whether this is actually going to happen – after all, Japan's government debt is now set to explode further, as the government has already announced it will engage in increased spending to help finance the clean-up and reconstruction.

Therefore, the government is still faced with the problem that it can not possibly afford to pay higher interest rates on its debt – which a change in the BoJ's policy stance would no doubt bring about.



1   The Atomic Samurai

At the time of writing, the fate of the Fukushima Daiichi nuclear plant  remains uncertain. TEPCO, the utility that owns the plant has managed to restore power to reactor unit 2 and has begun to spray water on reactor unit 3 with police water cannon that are normally used to disperse demonstrators. It is impossible to verify whether this water actually reaches its destination, the container where the plant's spent fuel rods are held. The spent fuel rods contain plutonium, as unit 3 is run with MOX fuel as we have previously mentioned – and this makes them currently the biggest problem. Plutonium is absolutely deadly when inhaled, so it would be very bad indeed if it entered the atmosphere.

The 180 strong work crew fighting the good fight at the plant are now referred to as the 'Atomic Samurai' in the press. It is in effect a suicide squad, sacrificing itself in an attempt to save all of Japan. The immense courage of these men deserves the greatest admiration. Below is a picture of the container holding the spent fuel rods at unit 3.



Container holding spent fuel rods at the Fukushima Daiichi plant. The water in this container has apparently evaporated, which could restart the reaction process in the spent rods. This has now become the biggest concern at the stricken plant.

(Photo credit: Jiji Press/Agence France-Presse – Getty Images)



We keep hearing about the various levels of radiation measured around the nuclear plant and elsewhere in Japan. Below is a chart that shows the effects of different levels of radiation (in milli-Sievert) on human health. This should help readers to put the numbers into context.



The effects of nuclear radiation (in milli-sievert) on the human body – click for higher resolution.

(Image via missionquest.freepowerboards.com)



Meanwhile it turns out that Wikileaks is once again very helpful – this time in  in understanding where the responsibilities for the nuclear disaster lie. It has turned out that its leaked diplomatic cables contain a wealth of information about Japan's nuclear security measures, or rather, the lack thereof. For many years, officials as well as TEPCO's managers ignored warnings and covered up the safety problems at Japan's nuclear plants. Now Japan suffers for this irresponsibility and negligence.


2. Lybia:

The quote of the week comes from Libya's Muammar Qaddafy in the form of some unintentional black humor. As the dictator remarked:

'Thank God Libya isn't as bad as Japan'.

His forces meanwhile threatened to overrun the last stronghold of the rebels, Benghazi.  This has prompted the US and others to urgently seek a UN vote on military intervention with the intention of imposing a no-fly zone in Libya, which the UN promptly approved.

As a first reaction, Qaddafy has now declared a cease-fire. He is evidently quite keen on ensuring his own survival by any means. According to the Irish Times:


Libya’s foreign minister has said it is declaring a ceasefire and ending all military operations following the UN Security Council's decision last night to authorise a no-fly zone.

“Libya is a full member of the United Nations. We accept that it is obliged to accept the UN Security Council resolution,” Moussa Koussa told a news conference in Tripoli. “Therefore Libya has decided an immediate ceasefire and the stoppage of all military operations.”

He said Libya "takes a great interest in protecting all civilians" and it also protect all foreigners and foreign assets in the country.

He said the ceasefire “will take the country back to safety”, but also criticised the authorisation of international military action, calling it a violation of Libya’s sovereignty.

The announcement, which came as British, French and US prepared to send military aircraft to protect the rebel stronghold of Benghazi, will be treated with caution by Western powers, mistrustful of Libyan leader Muammar Gadafy. “We will judge him by is actions, not his words,” British prime minister David Cameron told Channel 4 this afternoon.“


Libya "takes a great interest in protecting all civilians"? That really takes the cake.


3.    David Stockman's Hazlitt Memorial Lecture

Lastly, we also want to point readers to an excellent analysis of where the monetary system finds itself  40 years after Nixon threw the 'gold anchor' overboard, by David Stockman, the former director of the Office of Management and Budget under President Ronald Reagan. This was his 2011 Henry Hazlitt Memorial Lecture, given on March 12 at the Austrian Scholar's Conference. It can be found here: 'The End of Sound Money and the Triumph of Crony Capitalism'



Charts by: Bloomberg, StockCharts.com, Michael Pollaro



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2 Responses to “Ganging Up on the Yen”

  • Bearster:

    Pater: Thanks for another great article. I am one of those mad/intrepid souls short the yen at the moment!

    I am surprised by one thing: your agreement with Stockman. If the entire banking system is insolvent (I agree, btw) as a result of its fractional reserve banking (I think it is a result of duration mismatch, not fractional reserves per se) then wouldn’t you agree that the system was headed for a major crash in fall 2008?

    My personal view is that as a result of decades of falling interest rates, inter alia, capital has been destroyed in massive (and obviously impossible to quantify) amounts. This is the ultimate cause of busts: capital is destroyed via malinvestment and consumption, etc. 2008 was going to be the Mother of All Busts. So they intervened. They postponed the day of reckoning.

    Btw, I do *NOT* defend bailouts. The solution is not to have a central bank, irredeemable paper money, economic dictators arbitrarily setting interest rates, etc. Once the bust comes, as Mises noted, you can take it voluntarily or if you refuse you will destroy the currency, and suffer much the greater consequences as a result. This is the path I think we are inexorably on: total collapse of the worldwide regime of irredeemable paper currencies, central banking, and the vast financial system built on it.

    • Yes, I would definitely agree that the system was headed for a major crash in 2008, in the sense that a number of large institutions would have gone bankrupt without the interventions (BofA and Citi for instance, to name two of the more prominent ones). I do however agree with Stockman that this wouldn’t have been the calamity it was painted as. While certainly very painful for the economy in the short term, it would have been a rapid cleansing out of unsound credit and a repricing of assets that could have provided us with a much sounder basis from whence to resume genuine, sustainable economic growth. The bailouts have instead saddled us with the continued existence of these incompetent stewards of capital and condemned the economy to a long term malaise.
      Note by the way that even in the event of their bankruptcy, these large financial institutions would have resumed life as much smaller, but at the same time much sounder, companies after their restructuring. Their assets would have been taken over by more capable hands. Instead the decision was made to reward the reckless to the detriment of the prudent.
      On the other hand, the inevitable demise of the system of irredeemable currency will probably be hastened because of this.

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