Yen interest rates are at 0.1 percent, the lowest in the world. The two things that determine the strength of a currency are its trade cash flows and its investment cash flows. Japan has a trade surplus, which means when the funds from overseas sales are repatriated, the Japanese have to buy yen. This keeps the currency strong. Why then was the yen so weak, in the 120 range for so long?
You may remember we have often written about the carry trade, where the Japanese invested their money in other currencies with a higher yield. In doing so, they sold yen and bought the other currency, which devalued the yen. This kept the yen weak. The yen has since strengthened, because as the credit crisis took hold, the carry trades were unwound and the carry trade investments returned home, strengthening the yen below 100 and adding incoming funds to the trade surplus. The Chinese central bank put a lot of money in the U.S. during the credit crisis. The Chinese bank then switched over to investing in euros, and the euro sovereign debt crisis occurred. It seems to make sense that the next diversification would be into yen, as the yen was holding its strength and historically it has not been as volatile as other currencies. Chinese net purchases of Japanese debt have increased to 1.7 trillion yen in the first six months of 2010, up from 255 billion yen in the whole of 2005. This has helped offset the 2.8 trillion yen of net buying of overseas assets. When you add in the trade surplus, the yen is a currency with net inflows. That is why it is at its strongest in 15 years vs. the U.S. dollar.
The Value of the U.S. Dollar vs. the Rest of the World
Often on financial television shows and in publications you will see commentators talk about commodity prices going up because of the dollar. What do they mean?
If the U.S. economy is getting worse, then it means the U.S. is not worth as much. The thermometer of a country, economically, is its currency. Therefore, if the currency is worth less, it is not worth less just against other currencies it is worth less against everything.
We use dollars every day, so we don’t think of them as changing. A dollar is worth a dollar. But step back and look at it as part of the world’s economic system. If you want to buy copper from Indonesia, that country can sell its metal to any country and be paid in any currency, so the value of our currency is compared to the value of other currencies, from Indonesia’s perspective. What this means is that the price of the copper goes up in dollar terms, but the dollar has not changed from our perspective. Copper costs us more not because of supply and demand, but in this case, as commodities are priced in dollars, the cost of a commodity rises because the value of the dollar when compared to everything else is falling. As the commodity price rises, so does the value of the other currencies. In non-U.S. currency terms, the costs of the commodities remain nearly the same.
Why in this case is the value of the dollar falling? It normally boils down to how much currency there is. How much money is the Federal Reserve Bank allowing to be out in the world? Last week the Federal Reserve in a statement inferred that it might embark on more quantative easing, increasing the amount of money in circulation in an attempt to help the economy pick up. The result was the prices of commodities jumped higher.
This brings us to the components of the money supply:
- How much cash is in circulation
- How much personal debt there is
- How much government debt is issued
The point is that too much money in a system devalues the money. If there is less money in circulation, it stops it from being devalued. So money is itself a commodity. As we all know, commodities go up and down in price, driven by supply and demand — basic economics. Unless, of course, your currency is the one the commodities are priced in!
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