Tim Duy: Yen Intervention, or Why Japan is Now Carrying China’s Water

Yves here. I’m a fan of Tim’s work on the Fed beat, and consider this post on the implications of the announcement tonight of Japan’s intervention to lower the value of the yen to be particularly important.

By Tim Duy, the Director of Undergraduate Studies of the Department of Economics at the University of Oregon and the Director of the Oregon Economic Forum, who writes at Tim Duy’s Fed Watch

At the beginning of August, I wrote:

Now, suppose Japanese officials believe that intervention is required regardless of the G-20. Presumably, they will give US Treasury Secretary Timothy Geithner a phone call to at least keep him in the loop, if not to receive his implicit consent. One wonders if Geithner will recognize what he would be consenting to: Japanese intervention, if it occurs, means that Chinese authorities managed to get Japan to acquire their Dollar reserves for them. Instead of buying Dollars, China buys Yen, which in turn induce Japan to buy Dollars. This maintains the artificial capital flows to the US while allowing China to escape accusations of being a “currency manipulator.”

Since then, Japan’s currency challenge only intensified, culminating in last week’s almost comical complaint from Japanese policymakers:

Japan’s government said it will seek discussions with China over the nation’s record purchases of Japanese bonds as an appreciating yen threatens to undermine an economic recovery.

Japan is closely watching the transactions and will seek to maintain close contact with Chinese authorities on the issue, Vice Finance Minister Naoki Minezaki told lawmakers in Tokyo. Finance Minister Yoshihiko Noda suggested at the same hearing that it’s inappropriate for China to buy Japan’s bonds without a reciprocal ability for Japanese to invest in China’s market.

Did policymakers recognize the irony of their situation? It is not exactly a secret that Japan has made frequents excursions into the currency markets. But apparently they feel that intervention should be limited to Dollar purchases. Surely another Asian nation wouldn’t play the same game on them?

Alas, the Chinese did – under pressure to “loosen” the renminbi – and pushed the Japanese into intervening last night to tame the surging Yen. In effect, the Chinese managed to get the Japanese to do their Dollar buying for them. Honestly, I have a hard time faulting the Japanese. They are facing a serious deflation problem, and pumping Yen into the system is an appropriate response (all though, they might simply sterilize the intervention, which would be, in my opinion, a policy error).

What must be going through the head of US Treasury Secretary Timothy Geithner at this point? After all, as far as global imbalances are concerned, if he can’t stop central banks from intervening in the Dollar, he really isn’t going to be making much progress on reversing the deteriorating US trade deficit . And before anyone gets too excited about the most recent trade numbers, note the trend remains intact. Moreover, CR is tracking the LA ports data, and it looks ugly). Geithner is now out and about trying to jawbone Chinese officials. From his interview with the Wall Street Journal:

WSJ: Are you satisfied with China’s progress on the yuan?

Geithner: Of course not. China took the very important step in June of signaling that they’re going to let the exchange rate start to reflect market forces. But they’ve done very, very little, they’ve let it move very, very little in the interim. It’s very important to us, and I think it’s important to China, I think they recognize this, that you need to let it move up over a sustained period of time.

So, Geithner finally realizes the extent of the Chinese nonevent. Recall the press fanfare that accompanied the initial Chinese currency announcement – journalists falling all over themselves to speak brightly of China’s economic maturation. How many of those stories were sourced by Treasury officials crowing about the breakthrough that allowed them to avoid labeling China a currency manipulator? And where does this leave Geithner? Either complicit in trumping up the most minor of policy adjustments, or completely sucker punched by his Chinese counterparts. Honestly, I don’t know which is worse.

What it all boils down to is this: There apparently is no motivation for global central banks to stop directing capital inflows at the US in an effort to support mercantilist objectives. If it isn’t China, it will be some other economy. And equally apparent, there is no motivation among US policymakers to address such government directed capital flows. Which will leave politicians falling back on ultimately harmful trade barriers. The absolute inability of US policymakers to seriously address a global financial architecture where a rule of the game is “when in doubt, by Dollars” will ultimately have serious consequences via disruptive adjustment when the system can no longer be maintained, via either external or internal forces.

Print Friendly
Tweet about this on Twitter10Digg thisShare on Reddit0Share on StumbleUpon0Share on Facebook0Share on LinkedIn0Share on Google+0Buffer this pageEmail this to someone

24 comments

  1. Tao Jonesing

    Yves (or somebody),

    Could you post a primer of currency exchange rates, why they matter, and how they’re determined?

    More importantly, what the heck does this mean ” And equally apparent, there is no motivation among US policymakers to address such government directed capital flows. Which will leave politicians falling back on ultimately harmful trade barriers. The absolute inability of US policymakers to seriously address a global financial architecture where a rule of the game is ‘when in doubt, by Dollars’ will ultimately have serious consequences via disruptive adjustment when the system can no longer be maintained, via either external or internal forces.”

    On the one hand, I understand what you are saying. On the other, it strikes me as cognitive dissonance. “No motivation,” “harmful trade barriers,” “absolute inability,” these phrases all smack of attempting to force reality to converge with expectations. “No motivation” is, in fact, complicity. “Harmful trade barriers” is, in fact, treating citizens as citizens to be protected instead of consumers to be exploited. “Absolute inability” is, yet again, complicity– learned complicity.

    What does it take to break free of this farce?

    1. Yves Smith Post author

      Currencies can and do trade away from fundamentals for such protracted period that it is hard to speak meaningfully of how prices are formed. And some rule of thumb have been turned on their head. When I was young, a high yield currency was viewed as suspect because the yield meant it was due to be devalued. Now they are prized by currency traders when risk appetites rise. Japan’s fundamentals say the yen should be much cheaper, but China has been buying yen.

      Re Tim Duy’s last paragraph, he might have unpacked it a bit more. Most economists agree that for the US to raise trade barriers now when the economy is slack would be a plus. But China is unlikely to take that lying down, and tit for tat could easily escalate into a full blown trade war.

      Tim is arguing that China is pushing the current Bretton Woods II system to destruction. They presume we won’t dare retaliate, but if unemployment stays stuck at current levels, Congress is increasingly likely to take action.

      1. Ignacio

        You posted an interesting article by Reich who said that corporate America is divided in companies that don’t care about unemployment in the US, because they profit from globalization, and companies that care because their market is the US. If congressists are well paid by the former, retaliation may well not occur.

        1. scraping_by

          I noted all Reich’s examples of foreign sales are countries that base their national wealth on a trade surplus with the US. So the multinationals are essentially getting their business from the US citizen/consumer, by way of mercantilist trading partners.

          Something about that feet of clay thing.

          Money above and below the table keeps globalization alive, just as kickbacks and bribes keep privitization alive. No argument is as compelling as money. Law enforcement, such as the laws are, is dismal so they’re going to keep selling us as long as we keep voting on abortion, flag burning, sex scandals, race hate, etc.

      2. don

        “But China is unlikely to take that lying down, and tit for tat could easily escalate into a full blown trade war.”

        Oh, the horor! But Paul Krugman has aptly characterized this threat: “They are holding an unloaded squirt gun to our heads.”

  2. ds

    The problem is that free trade and fair trade are mutually exclusive goals. Our commitment to free trade is what makes Chinese mercantilism possible, so it is hard to understand the economists who worry about trade imbalances while at the same time warning of the dangers of protectionism.

    In the end, this is really a diversion. We are no longer on a gold standard. Our currency is non-convertible and free floating, so any capital outflows can be substituted with new injections of money via domestic fiscal operations. In a fiat monetary regime, the federal government has all of the tools at its disposal to promote an economy with full employment and high capacity utilization. Our failure to utilize these tools has more to do with domestic politics and ideology than anything relating to foreign trade relations.

    If China or whomever wishes to game the system of free trade then that is their prerogative. Let them send over as many containers of goods as they want in exchange for electronic credits to their reserve account. Whatever spare capacity this leaves us with can simply be re-employed in the service of other, more useful aims.

    1. Hubert

      It really is only a hunch so far: Does somebody share my impression that the current Japanese government is not liked too much by the US?
      May the appreciation of the Yen and the pressure on the Nikkei be a tool for regime change in Japan ?
      If yes, has anybody an idea of its chances to effect this change ? INversely asked, how isolated might the BoJ be in its attempt to bring down the Yen ?

      1. purple

        The U.S. already toppled the Japanese regime they didn’t like, when Obama asked Hatoyama “Can I Trust You” over Okinawa, effectively humiliating him and rendering his coalition dead. This was widely reported in the Japanese press.

        1. Hubert

          Yes, I remember that somewhat. Question is, what about the current Japanese government ? They looked very helpless in terms of their currency up to now too. Is Washington just watching the Chinese pressing up the Yen or is there policy behind it? Benign neglect ?

    2. sean

      Nothing is wrong with free trade when both sides allow a free market. When you allow free access and the other person does not it causes problems.

      I have no idea how to deal with the China problem, I don’t like protectionism but it almost has to be an option at this point.

    3. Mac

      “If China or whomever wishes to game the system of free trade then that is their prerogative. Let them send over as many containers of goods as they want in exchange for electronic credits to their reserve account. Whatever spare capacity this leaves us with can simply be re-employed in the service of other, more useful aims.”

      So the US better start cracking on the 9.5%+ (official)/15%+ (unofficial) unemployed. Any suggestions on what services they can provide?

      Note that there have been reports that businesses cannot find the correctly trained people – one way to look at that is no business is prepared to train folks. So who will?

  3. Hubert

    (Sorry, post was not meant as a reply to above post…)
    It really is only a hunch so far: Does somebody share my impression that the current Japanese government is not liked too much by the US?
    May the appreciation of the Yen and the pressure on the Nikkei be a tool for regime change in Japan ?
    If yes, has anybody an idea of its chances to effect this change ? INversely asked, how isolated might the BoJ be in its attempt to bring down the Yen ?

  4. CingRed

    Excellent article.

    Geithner should have gotten a clue when the Chinese university students laughed at him during his speech some months back. They viewed him as an idiot then and he just keeps reinforcing that perception. The Chinese are smart, methodical and tenacious, and if they want to keep manipulating their currency to their advantage they will find a way to do it. Their play on the Yen is just one example of that. Timmy doesn’t have enough fingers to keep the dike from leaking and he’s not smart enough to beat the Chinese in this game. The insanity is that Geithner is still holding his position at the Treasury instead of working for H&R Block as a seasonal tax processor but he probably couldn’t pass the ethics criteria for that job.

  5. lark

    This is one of the handful of areas where I finally threw in the towel on this Administration.

    What a bunch of wimps.

    Democrats are fatally compromised by ties to multinational corporations, who in turn have no loyalty at all to these United States. We The People get screwed.

    Here’s a quote that shows who and what the Administration is kowtowing to, our real rulers:

    “Companies that are multinationals with corporate headquarters in the States, regardless of size, have no moral or ethical obligation to do what’s best for America or Americans – unless directed to do so by their shareholders. MNC executives only have one obligation: To increase shareholder value. That’s it. It’s that simple.

    If offshoring will improve a Company’s bottom line, then so be it….Although it’s hardly desirable, job loss that may result is irrelevant…”
    http://www.sandhill.com/opinion/daily_blog.php?id=52&post=279

    Ross Perot was right. I’m sorry to say I swallowed the globalization and free trade snake oil that Clinton was selling, and didn’t wake up until the Bush era.

    Is it too late?

  6. Lil'D

    I’m a bit hazy on “sterilization”… is that an attempt to keep the monetary base stable while making the currency trade? How is it implemented?

  7. Karen

    Help – I’m so confused!

    Why couldn’t the BOJ have sold yen and bought renminbi instead of dollars? Is it that the Chinese central bank buys dollars – and now yen – from their own exporters, and Japan doesn’t have enough exporters willing and able to sell renminbi to do the same thing vis-a-vis the Chinese?

    A separate question is, why can’t the Japanese maintain a healthy economy despite a long-running trade surplus that should mean they are very wealthy? Even with a big trade surplus that’s been there year after year for decades, somehow they can’t keep their people employed? Where does all the money go, into a black hole?

      1. Karen

        So I guess that must mean they buy their dollars from Chinese companies…

        How do they handle the situation where a multinational company (such as Honda) needs renminbi to pay its Chinese workers and other expenses associated with production facilities in China? Do those companies typically have enough Chinese earnings to pay all their Chinese expenses, or do they have to trade currencies to get that done?

        Does not allowing foreigners to buy renminbi violate any WTO rules?

  8. KnotRP

    > But China is unlikely to take that lying down,
    > and tit for tat could easily escalate into a full blown trade war.

    You don’t think it’s already a full blown trade war?
    The only distinction right now is US employees are taking
    all of the bullets, while the elite say ‘be nice, maybe they’ll
    stop shooting”.

  9. Pat Walker

    Please forgive someone earnestly trying to understand.

    The US consumer/businesses buys inexpensive (quality is immaterial) physical goods from China and they get electronic credits — a perception of value, because our fiat currency system –the dollar– is non-convertible to anything other than itself. Since it free floats, when the dollar gets cheaper, supposedly we can export more Made in USA tangible products or intangible services.

    To an average Joe like me, if I’m buying groceries — milk, eggs, etc. that’s produced here, or services like a haircut, plumber etc. — or pay rent or keep up with the mortgage (assuming I CHOOSE TO) the effect of the free-floating dollar is negligible. If I drive a foreign car, — BMW Hyundai or Toyota, — the parts will get more expensive but the local labor to install it won’t. If the Yuan gets more expensive, then I assume goods at Walmart or Chinese imports like the I-Pad/Pod/Phone will get more expensive until Walmart loses enough business because they can’t pass on the cost readily, and they will look for other, more local third world suppliers (Mexican, Guatemalan, Canadian-with apologies– etc.)

    So, really, in the end whose better off? The US with actual, physical goods or the Chinese with lots of electronic credits (bits and bytes).

  10. RebelEconomist

    In my opinion, the US would be within its rights to simply refuse further treasury debt purchases from China (as I have been arguing here and elsewhere for years: http://reservedplace.blogspot.com/2008/10/just-say-no.html ). This would be an appropriately targeted measure, given that China does not allow other countries to buy renminbi debt. One can speculate why the US does not do this; perhaps they feel they need China to finance the twin deficits.

  11. Lester

    Trade barriers against who? Limiting imports from China will not address the situation as it will merely change the source of those imports to other developing nations, who will then be the new buyers of the Dollar. The only way to curb the issue would be for the US to ban all imports. It is highly unlikely (and in fact detrimental) for the US to do so, as its industries simply does not have the capability to provide the same kind of consumer surplus that developing countries can, what with the minimum wage etc.

Comments are closed.