Why Japan’s FX intervention might actually work

September 15, 2010
trying to push it down.

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Has a central bank ever intervened successfully in the foreign exchange market when the momentum trade was against it? The yen has been rising alarmingly of late, and now the Bank of Japan is trying to push it down.

At first glance, the action looks like a something-must-be-done-this-is-something-therefore-this-must-be-done move: a new prime minister and a “bold action” doomed to be proved ineffectual. The FX markets are so enormous (dollar/yen alone trades some $750 billion per day) that it’s hard to believe a single sale of less than $20 billion in yen could even have the short-term effect we saw last night, let alone have any lasting consequences.

But this isn’t just about FX-market intervention. This is also about monetary policy, and that could make a real difference:

Unlike in previous forays, the Bank of Japan will not drain the money flowing into the economy as a result of the yen selling, sources familiar with the matter said.

That indicated the central bank plans to use the sold yen as a monetary tool to boost liquidity and support the economy.

Authorities that sell their own currencies to weaken them often issue bills to “sterilize” the funds and keep the excess money from becoming inflationary. In Japan’s case, it wants to promote inflation since the economy has been dogged with deflation for much of the past decade.

“The government’s aim, and the aim of authorities in general, is to add monetary injections to the economy,” Callum Henderson, global head of foreign exchange strategy with Standard Chartered in Singapore, told Reuters Insider.

“Unsterilized intervention should be yen-negative, it should be very bullish for higher risk assets, very bullish for stocks in Japan and obviously it should add to the impact of the intervention of the yen,” he said.

In other words, the Bank of Japan isn’t simply selling yen, it’s printing yen. (And then selling them.) Given (a) that it’s the central bank and that it can print as many yen as it likes, and (b) that it would actually welcome a bit of inflation, there’s actually a non-negligible chance that this kind of non-sterilized intervention could work.

Of course, a hint of inflation in Japan could end up driving Japanese bond yields up. That in turn could make a huge difference to the government’s annual interest bill on the country’s monster national debt. So this kind of policy is hardly cost-free; indeed, the real costs might well be much larger than the nominal size of the intervention. But at least it has a chance of making a difference, which is more than you can say for most currency interventions.


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