Saturday, March 26, 2011

Japan Has Run Out of Bullets - The Implications of Joint Intervention

In an earlier post, I had opined on whether it was time to buy Japanese securities after the immediate effects of the tsunami, earthquake, and nuclear meltdowns. At the time, I believed government intervention was possible - indeed even likely. However, I had not reckoned on the extent of intervention.

For years, analysts believed that the Japanese authorities had been rendered powerless from perpetual deflation as expressed in near zero percent interest rates. With rates already at record lows, there was no further room to cut and bond bears eagerly gathered around the short JGB (Japanese government bonds) trade. But instead of rates rising, the central bank was able to maintain rates at record lows for years and frustrate the shorts. The reasons behind this anamoly are two fold - one, most of the demand is domestic and two, regulatory barriers discourage foreign speculation. Indeed, Japanese corporations and elderly pensioners are sitting on an estimated cash hoard of at least ¥1,500 trillion ($18 trillion) of savings. But that was before the natural disasters of mid-March.

The worst two-day rout in 40 years caused a 6.2% drop in Nikkei share index, wiping £90 billion (roughly $145.45 billion) off stocks. The yen rally to a postwar high of
against the dollar of Y76.25 on March 16. In a desperate attempt to stabilize the markets, Japanese authorities printed an astounding amount of money. The numbers are mind boggling - 15 trillion yen ($183 billion) in liquidity during the first week and then an additional 13-15 trillion yen in the following week for a total of 28-30 trillion yen. The BOJ also intervened in the currency markets by selling over
Y2,000bn ($25bn) against the dollar on March 18. Other central banks followed in an extremely rare joint operation. Japan has essentially run out of bullets and is now borrowing cartridges from other nations.

While the exact amount of currency sold to weaken the yen is unclear what is clear are the implications behind the currency operations. In the past year, myself and other pundits had mused that the G20 was the new organization that had superceded the G7/8 in influence (Canada was the last member to be invited to join) after the financial crisis of 2008-2009. The interventions of mid-March proved that the G8 economies (USA, Great Britain, Canada, Italy, France, Germany, and Japan) continue to retain considerable power in world financial markets. While emerging markets such as China, Brazil, India, and (arguably) Russia are leading world growth, the centers of financial and political stability continue to emanate from the developed world.

The takeaway message here is that more - not less - government intervention is here to stay for the foreseeable future. Even though individual governments may have exhausted their own financial resources they can rely on tools such inter-bank swaps, forwards, and no interest loans (to name a few) from other nations. World governments have learned from their lessons in 2008 and 2009 that coordination is essential to bringing stability to financial markets. This has important implications for volatility and the Bernanke put in the coming months. But that is a topic for another time.
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