Currencies

[thepennyking]

Japan Gets Wish With Dollar Short Squeeze: David DeRosa
Feb. 22 (Bloomberg) -- Japanese officials must be pinching themselves to make sure Friday's better-than-two-yen rise in the dollar was for real. Hopefully, they will note that the movement of the dollar against the yen happened without the Bank of Japan being a market participant.

Probably not -- Japan is adamant that it won't allow appreciation in the yen. And it has shown that it's prepared to use the full weight of its central bank against the currency market.

The move in the yen actually started on Thursday. The yen was trading at 105.50 when the dollar seemed to catch a lift. By the end of the day it was trading at the 107 handle. The real fireworks happened on Friday when the dollar vaulted over the 109 level.

Part of this drama was caused by Japan's finance ministry saying it may keep selling the currency and by an announcement that Japan's Prime Minister Junichiro Koizumi had raised the terrorism alert to its highest level since March. This is a knee- jerk reaction: If Japan is a target, sell yen.

Accumulating Dollars

Part of the yen's rise on Friday had to do with it being Friday, which is the day that's notorious in the foreign exchange market for short squeezes. That's when panicked short sellers, in this case traders with short positions in the dollar, are forced to cover for fear of immediate capital losses. And once the squeeze begins, it's hard to find anyone who isn't a buyer of dollars, meaning the price action is a one-way street.

A measure of Japan's determination to cap the yen's rise is its record accumulation of dollars, hence selling yen, over the past year. Those dollars were used to buy U.S. Treasury bonds. Japan's purchases totaled $167 billion in 2003.

All of this is rooted in a deeply held belief that Japan is an export economy. If its currency rises in value, it fears its goods could be priced out of international markets, and, in particular, the U.S. market.

Whether that's true, Japan nevertheless thinks it must act against the strengthening yen. Yet in recent times, Japan has achieved little relief from the strengthening yen for all its Herculean efforts.

Not So Fast!

That's why it's ironic that the yen could drop so quickly without the direct help of the Japanese government, although it did play a small role.

The market has been impressed by recent economic numbers coming out of Japan that indicate a turnaround at long last. The number that grabbed the most attention was last quarter's gross domestic product: Japan's economy grew at a 7 percent annual rate in the three months ended Dec. 31, the government said on Wednesday. That's the fastest pace in 13 years, and faster than the U.S. or Europe.

Time to buy yen, one might presume. If Japan turns around, then there should be a flood of money into the Japanese stock market, and that would take a lot of yen purchases.

Not so fast, according to Japan's vice finance minister for international affairs, Zembei Mizoguchi.

He basically said, ``Buying of yen on good news won't be tolerated!'' And to make his point, he did say that it ``won't be the case'' for Japan to allow the yen to appreciate, even if the economy is expanding.

Why Fix It?

This is as curious as it is Draconian. If Japan is growing at 7 percent, then why mess with the foreign exchange market? If the economy is working, Mr. Mizoguchi, why try to fix it?

Consider the consequences of holding down the yen against the dollar in the midst of a recovery -- assuming that's what is happening in Japan. A lower yen makes the cost of entering Japanese markets artificially cheap for foreign investors.

And sooner or later the yen will rise because we know the Bank of Japan can't really control the currency. All of this could mean that Japan's official yen policy ends up creating a stock market bonanza for foreign investors.

This may sound silly considering the last 13 years of economic torpor in Japan, but could it now be risking a repeat of the 1980s?

If the economy really is on the mend, and the BOJ keeps the yen lower than it should be, then the policymakers are risking creating a tidal wave of international funds rushing into their country.



To contact the writer of this column:
David DeRosa in New Canaan, Connecticut, or [e-mail]

To contact the editor of this column:
Bill Ahearn, or bahearn@bloomberg