Japan unilaterally intervened in currency markets on Wednesday, buying dollars and selling yen.
The yen has appreciated about 10% against the dollar this year—for a country highly reliant on exports, the currency rise has hurt economically.
Unilateral currency intervention is largely ineffective in the long haul without coordinated action by other central banks.
What's more, currency intervention could actually end up hurting the very economies they are supposed to help because of negative, unintended effects.
Japan unilaterally intervened in currency markets on Wednesday, buying dollars and selling yen in a bid to weaken its currency from 15-year highs against the greenback. Though the intervention was a largely unexpected and bold shift in Japanese currency policy, it may ultimately amount to no more than a small ripple in a large pond.
The yen has appreciated about 10% against the dollar this year. For a country highly reliant on exports, the currency rise has hurt economically. Japanese exports are less competitively priced abroad and repatriated foreign income suffers depreciation. Hence, firms with foreign sales have put pressure on the government to stem the yen from rising further. However, unilateral currency intervention isn't without stigma due to its "beggar-thy-neighbor" nature and hasn't been used in years by most major developed countries. The only developed country to do so recently is Switzerland, which bought about €90 billion euros (nearly $111 billion) to weaken the Swiss franc against the euro in early 2010.
Besides possibly annoying major trading partners, a more important reason unilateral currency intervention has fallen out of favor is because it's largely ineffective in the long haul. Though a central bank's foreign exchange sales may achieve short-term results—like the spike in the dollar-yen exchange rate Wednesday—without coordinated action by other central banks, the results get muted over time by the enormous global volume of foreign exchange trading. According to the Bank for International Settlements, average daily turnover in foreign exchange markets has risen 20% to $4 trillion since 2007.
Estimates place Japan's Wednesday currency interventions at around ¥1 trillion in total (about $12 billion), though government officials hinted this might only be a first step. The last time Japan intervened in currency markets was six years ago, when its Ministry of Finance conducted operations totaling ¥35 trillion in a series of operations from January 2003 through March 2004. Of course, those efforts didn't stop the yen from further appreciating. Likewise, Switzerland abandoned its major intervention efforts in June after they failed to achieve sustained results.
What's more, currency intervention could actually end up hurting the very economies they are supposed to help. Besides potential retaliation (with other countries also intervening to weaken currencies—though this looks unlikely in Japan's case), sometimes currency policies can run counter to economic growth policies. Russia raised interest rates from 11.5% to 13% in November 2008 to bolster the rapidly falling ruble and maintained elevated rates through March 2009—a time when it should have aggressively cut interest rates like the rest of the world to boost economic activity. Venezuela's strict foreign exchange policies are leaving its domestic companies short on cash and curbing business activity.
At the same time, Japan's recently strong yen shows the fickleness of currency trends. And it helps to dispel preconceived notions about what makes a currency strong or weak. The yen has risen despite a middling economy in the shadows of deflation, constant political turnover and uncertainty, and a very high government debt load relative to GDP. Those fearing US debt, deficit, politics, economy, or whatever must weaken the dollar need look no further than Japan to see that's not necessarily the case.
Fact is: Sometimes currency intervention is effective (often when it's multilateral) and sometimes it's not. And when it's not, it can cost more than just the amount spent in foreign exchange markets. Interventionist policies can spin off negative, unintended effects that hurt economies. It remains to be seen if Japan takes further steps in weakening the yen and what those steps may be. There are loose talks of monetary easing. We're all in favor of policies that help boost economies—but that's not always a given with currency intervention despite the intention.
Perhaps the yen-selling is also a symbolic gesture by Japanese Prime Minister Naoto Kan, who won a narrow 206-200 vote victory among lawmakers in his Democratic Party of Japan (though he won a large majority among the party members) earlier this week. His rival in the elections pledged aggressive action to help the Japanese economy—and maybe the currency intervention is Kan's way of showing he's also up to the challenge. Either way, we hope Japan keeps in mind the lessons learned from 2003 and 2004 and from poor outcomes of currency intervention policies around the world.