Taylor revisits Japan’s intervention in forex markets

Japan is intervening in currency market to prevent appreciation of Yen. This is done by buying US Dollars and selling Japanese Yen. There is an interesting development thatUS need not worry that Chinese will stop buying US Treasuries. Now with Japan buying USD there are high chances that the USD would also be deployed in US Treasuries.

Interestingly, Japan did that in 2002 as well. John Taylor  was U.S. Treasury Under Secretary for International Affairs. He recounts the experiences then.

I am writing from Tokyo where I have spent a few days at the Bank of Japan. This week marked the first exchange market intervention by the Bank of Japan since March 16, 2004, a day I remember well because it was the last day of a massive exchange market intervention by Japan amounting to $320 billion and now called the Great Intervention. As U.S. Treasury Under Secretary for International Affairs, I worked closely with the Japanese on the start and the exit from the Great Intervention.

Some have asked me to compare this week’s intervention with the start of that earlier intervention because the earlier one was closely related to the Bank of Japan’s quantitative easing, a subject which is back on the table. Indeed, some are speculating that the recent intervention might be the start of another large dose of quantitative easing, not only in Japan but elsewhere. Today’s Financial Times front page story, Monetary Easing Fears Lift Gold To Record High reports that “Traders said Tokyo’s intervention in the yen market, which injected fresh liquidity into the Japanese economy, was a sign that central banks were prepared to begin a new round of quantitative easing. Traders said the Federal Reserve could follow suit next week at its monthly interest rate setting meeting, and that gold would probably benefit from it.”

US usually objects to such currency management practices (just like it is doing with China now). But at that time, the idea was that this buying of USD and selling of JPY will lead to increase in money supply in Japan. So as long as BoJ does not sterilise the JPY flows, it should help kickstart the Japanese economy.  Hence, US agreed to such practices with the condition that Japan shares the information of how much intervention has happened per day.

After a few months into 2003, the unprecedented nature of the intervention became clear to everyone. The Japanese would not publicly announce their daily interventions, but the markets began to sense it, and at the end of each month the Japanese would report on the monthly totals. I had arranged for the Japanese to email me personally whenever they intervened in the market, and to call me about very large interventions. When I read email on my Blackberry in the early morning I would frequently find messages from Tokyo like “small intervention during Tokyo trading hours; 1.2 billion dollars purchased,” and I was awakened by quite a few late night or very early morning calls from Tokyo too.

And as Japanese economy improved (though not because of just this policy), Japanese decied to exit from this intervention policy. They selected a very strange way of exiting:

After a few months into 2003, the unprecedented nature of the intervention became clear to everyone. The Japanese would not publicly announce their daily interventions, but the markets began to sense it, and at the end of each month the Japanese would report on the monthly totals. I had arranged for the Japanese to email me personally whenever they intervened in the market, and to call me about very large interventions. When I read email on my Blackberry in the early morning I would frequently find messages from Tokyo like “small intervention during Tokyo trading hours; 1.2 billion dollars purchased,” and I was awakened by quite a few late night or very early morning calls from Tokyo too.

By the summer of 2003, the data began to show that the Japanese economy was finally turning the corner. Though it was too early to be sure about the recovery in Japan, it seemed to me that the Japanese could soon begin to exit from their unusual exchange rate policy of massive intervention. For the next few months we worked with the Japanese on an exit strategy. By early February 2004, the Japanese decided to complete the exit and Zembei called me to outline their exit strategy: They would intervene even more heavily in the next month and then stop. The idea seemed strange to me, but the Japanese had never tried to mislead me, so I knew that this was indeed their strategy.

Intervention did increase and it was not until March 5, 2004 that we really saw the beginning of the end of the intervention. At 8:30 that morning, Washington time, the U.S. Labor Department released their monthly employment report. Employment for the month of February was up by only 21,000 jobs, much less than we or the market had anticipated. News like this would normally have a negative impact on the dollar because weaker jobs data would lower the chances of an interest rate increase by the Fed, thereby making the dollar slightly less attractive to investors seeking higher interest rates. But the dollar did not weaken and on March 5 the Japanese had purchased $11.2 billion dollars that day which made the dollar appreciate rather than depreciate as one would expect. They were not simply smoothing the market, they were working against it. Zembei had told me that they were going to do more intervention before they did less, but this was simply excessive. He was working against market fundamentals. I called him over the weekend to complain that this type of intervention was completely unwarranted and I was as forceful as a friend and ally could be. Zembei acknowledged that they were still intervening heavily now, but the March 5 dollar buy was part of the exit plan. I argued that the exit period had gone on long enough.

Zembei did soon stop intervening, after another week of heavy dollar purchases, but nothing that equaled March 5. The last purchase of dollars occurred on March 16 when the Japanese bought “only” $615 million. On the 17th my Blackberry reported no intervention, and again on the 18th. There was no intervention for the rest of March and the rest of the 2004, and all the way through 2005 and now through September 14, 2010. The yen did not strengthen much in the months after the Great Intervention ended.

So what were the lessons? Taylor says the intervention did not work much:

My assessment, based on this experience, is that the recent intervention is not, and should not, be a repeat of the Great Intervention. While that intervention was not sterilized and quantitative easing occurred, many at the Bank of Japan did not think it was so successful. Moreover, the need for more liquidity in the Japanese banking system is not so obvious now. And the protectionist pressures in the United States are greater now, especially with the very weak U.S. economy. Complaints in the U.S. congress about the recent intervention are already greater than what we heard during the Great Intervention at the time.

All this is fine except that Japan banking system does not need liquidity now. Japanese economy is still under lot of problems. The banking systenm may be stable but because of deflation and stagnating economy quantitative easing (or some form of moentary expansion) is still needed.

Anyways, great insights from Prof. Taylor as always. This is where blogging really helps for students like me. In few words Taylor explains a lot about Japanese policies then. Otherwise one would have to read a full 4 page paper on the same…

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5 Responses to “Taylor revisits Japan’s intervention in forex markets”

  1. Taylor revisits Japan's intervention in forex markets « Mostly … — Investor Winner Says:

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  2. Taylor revisits Japan's intervention in forex markets « Mostly … | Forex Currency Trading Market Says:

    [...] is the original post: Taylor revisits Japan's intervention in forex markets « Mostly … « Forex Technical Update 9.17.2010 – Japanese Yen after Intervention You can [...]

  3. forexhug Says:

    nice article i like this one lol

  4. hasan Says:

    Thanks sir , it was indeed a very knowledgeable and gave me a very good insight. When did the latest intervention start? I mean are the japanese doing it again in 2010? And I could not relate how this intervention made a difference after buying so much USD? nyways thankyou so much.

  5. Jeff Harvey Says:

    Hi, this is great stuff! I am so interested in news and analysis. Is there a way that you can contribute to my blog http://forexjef.blogspot.com/ by posting such great insights as these?
    I would appreciate it very much since I’m a novice at all this.

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