It is worth pointing out some interesting reporting regarding last week’s G7 intervention. I think this summary via the Wall Street Journal is basically correct:
The Group of Seven’s coordinated efforts Friday to weaken the value of the Japanese yen are likely designed more to temper panicked markets than targeting a specific currency level, economists say….
“This is a short-term measure that has more the goal of stabilization and averting a short-run panic than taking a view about how global imbalances might evolve and what the right value of the yen is against other currencies,” said Ralph Bryant, a former director of the U.S. Federal Reserve‘s international finance division, now a fellow at the Brookings Institution.
I have a hard time reading anything more than the obvious into the G7 intervention. In response to the earthquake and subsequent tsunami the Yen was appreciating rapidly in what appeared to be a disruptive fashion. The Japanese authorities would have acted on their own sooner or later, but secured the backing of their G7 partners to provide evidence that efforts to stabilize the Yen should not be confused with attempts to direct the value of the Yen to achieve a trade advantage. It will work as a break on speculative activity, but will have limited impact, if any, on any long-run, fundamental forces driving the value of the currency. To fight the latter requires a committed, repeated effort on the part of the Ministry of Finance, something that at the moment does not appear to be on the table.
The Wall Street Journal also has a more curious piece relating the currency intervention to the Federal Reserve’s balance sheet that reads like it was rushed on a Friday afternoon. (which I can identify with, as most pieces I rush fall short of where they should be). The piece begins:
The Federal Reserve‘s contribution to a global effort to weaken the yen is limited by the central bank’s war chest of Japanese currency and currency-like assets.
The Fed’s modest holdings are indicative of the dollar’s position as the world’s key reserve currency…
…While reports from traders about the size of the Fed’s participation in Friday’s interventions were as uneven as one would expect in the absence of official confirmation — it seems they sold around $600 million — the overarching fact is the Fed doesn’t have much yen to sell.
I am not sure that we should care that the Fed doesn’t have much Yen to sell, but they seem to have plenty for this kind of operation:
According to fourth quarter 2010 data from the Fed, the most recent available, the central bank held a total of $11.922 billion in yen denominated assets. That consists of $3.882 billion in cash and $8.039 billion in securities, the type of which the Fed doesn’t describe.
Enough for ten ventures into the Yen market of the same magnitude as last week’s action – actually more since interventions are typically split between the Fed and Treasury. Seems like plenty given only a couple of interventions a decade. The article does get around to the critical point – the Fed is only a symbolic player in this effort. There is no problem finding Yen to sell. The Bank of Japan can print theoretically unlimited amounts of the stuff:
All of that points to participation by the Fed that’s important, but largely symbolic. In this action, “the impact is not going to come from the G-7, non-Japan. The holdings are just too limited,” said Tom Porcelli, economist with RBC Securities. The heavy lifting “is going to have to be done by the Bank of Japan” because they’ve got the yen to make a real difference, should that sort of force be required.
So, again, isn’t the size of the Fed’s holdings essentially a nonissue when it comes to beating down the value of the Yen? Sounds like a Japanese problem with a Japanese solution. The piece then takes an interesting turn:
The mechanics of the Fed acquiring more yen for its balance sheet are unclear. The New York Fed declined to say how it possess the yen and yen-assets it has, and did not say how it could get more if it wanted. It seems unlikely the Fed’s currency swap arrangements, which exist to provide dollar liquidity to major central banks, could be used to get more yen, given how they are set up.
Are the mechanics of reserve accumulation really unclear? After all, rather than issuing a “sell” order, the markets group in New York could instead issue a “buy” order. That should do the trick. If the problem is how can they get more Yen to drive down it value, it is a nonissue. See above – in the long run, this in the Bank of Japan’s problem, and they have the tools to deal with it.
I could live with all the above, but the article takes yet another interesting direction when it implies monetary policy implications:
The forecasters of Wrightson ICAP said the Fed may have had another reason for embracing the intervention. While the Fed would clearly be amenable to aiding Japan, “We suspect that at least some FOMC [Federal Open Market Committee] members would be pleased by the idea of zeroing out the Fed’s yen-denominated portfolio.”
That’s because it would streamline the eventual contraction of the balance sheet and help limit the options of future policymakers who wish to pursue foreign exchange interventions for more typical goals.
Wow. I usually don’t challenge the Wrightson ICAP research, and have much respect for their Chief Economist Lou Crandall. But wow. I imagine this could be true, but I have trouble believing that given the magnitude of the Fed’s balance sheet expansion, Fed officials are really looking for salvation in a piddling little $12 billion in Yen-denominated assets. Consider that they bought $6.58 billion of Treasuries last Thursday – 10 times the Fed’s estimated yen intervention. Are some FOMC members really secretly worried about the size of the foreign exchange holdings when they are in the process of sucking up $600 billion of Treasuries? If they are, I am indeed much more concerned about the Fed’s ability to contract the balance sheet when it becomes necessary, because there must be far less room for error than Fed officials even come close to acknowledging.
Moreover, how in the world does selling off the Yen portfolio “limit the options of future policymakers who wish to pursue foreign exchange interventions for more typical goals”? Isn’t the more “typical goal” to weaken the value of the domestic currency, in this case the Dollar? To achieve that goal, you need to buy foreign denominated assets. This can be accomplished even if the Fed has already dispensed with their foreign exchange reserves. (And, I should add, would not really be in the Fed’s purview, as the value of the Dollar is a responsibility currently held by US Treasury Secretary Timothy Geithner).
Bottom Line: Don’t read too much into the Fed’s participation in last week’s G7 intervention. Take it at face value – symbolic support to curb what can reasonably be described as a destabilizing Yen appreciation. No more, no less. Any sustained action of the value of the Yen will have to come from the Japanese authorities.