JIN-266 -- Adapting to Intervention -- What the Markets Need, and What they Know

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Issue No. 266
Wednesday, March 17, 2004

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@@ VIEWPOINT: Adapting to Intervention -- What the Markets Need, and
What they Know

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@@ VIEWPOINT: Adapting to Intervention -- What the Markets Need, and
What they Know

Currency markets are nervous places at the moment. The dollar may have
firmed up a little over the past two weeks, but everyone knows that the
potential still remains for some fairly wild swings. So we were a
little surprised when the Nikkei, in all its journalistic wisdom, flung
a new wrench into the wheels.

In an article that appeared without any named sources, the paper declared
that Japan's massive 30 trillion yen currency interventions would soon
be coming to an end. Down went the dollar; up soared the yen. A day of
total turmoil on Tokyo currency markets on Tuesday finally ended with a
statement from the Ministry of Finance (MOF) that it remained committed
to its intervention spree.

The markets, logical and trusting places that they are, had every reason
to believe the Nikkei story: It's precisely what some optimists have
been hoping to hear since the beginning of March. Rumors of an end to
Japan's staggering run of currency interventions also come amid strong
criticism of the policy.

The MOF and Bank of Japan lavished 20 trillion yen on interventions in
2003 and expended a further 10 trillion yen in the first two months of
2004. Analysts at Mizuho Securities have estimated that the MOF would
incur a whopping 10 trillion yen in paper losses if it calculated the
value of its dollar assets at an exchange rate of 110 yen to the dollar.

Finance Minister Sadakazu Tanigaki doused the flames further with his
line: "I won't comment on daily foreign exchange levels, but our stance
remains unchanged. We believe foreign exchange rates should move stably
in reflection of fundamentals."

Speaking in a parliamentary committee, Tanigaki also said that Japan
would continue to intervene against speculators trying to push the yen

We spoke to a few currency strategists who said they found the reports
of an end to intervention highly surprising, and even pointed out that
there was evidence of more intervention during the course of Tuesday
trading in Tokyo.

The rebuttals kept flooding in. Bank of Japan Governor Toshihiko
Fukui added his own coded denial of the rumors, saying that while
Japan's economy is in deflation, it is vulnerable to external shocks
such as foreign exchange market volatility -- precisely the sort of
uneven currency movements from which the Japanese government wants to
protect its export industries as they struggle to build a wider
economic recovery.

Mr Fukui agreed that when Japan overcomes deflation there may come a
time when less aggressive foreign exchange intervention would be needed,
but concluded that "now is not that time."

But the whole affair needs some close attention, particularly to the
motives behind the original Nikkei story. Let's assume for the moment
that it was not completely made up and that there are some senior
members of the MOF who are saying that the intervention will soon end.
What do they gain from putting it out there? The effect of a story
like that is to engender precisely the sort of wild movements that
the intervention is supposed to stop.

The trouble at the center of all this is something that the government
should start taking very seriously indeed: The markets have become
accustomed to the idea of intervention. They have started building it
into their long-term assumptions about what will happen to the
dollar/yen rate at particular levels. The very act of ending this
assumption will force the MOF into more intervention -- as long as
it remains true to the cause of smoothing irregular movements.

-- The Editors

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Written and edited by Roland Kelts and
Leo Lewis (editors@japaninc.com)


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