Can the yen ever be the un-dollar?
Binky Chadha and my friend Jens Nystedt of Deutsche Bank think so.
In a world where the (net) global flow of capital is increasingly dominated by official flows (Chadha and Nystedt note "emerging market central banks
are the largest participants in FX markets"), the yen's unpopularity as a reserve asset has certainly contributed to the yen's weakness. Emerging markets in particular are adding to the reserves (and oil funds) at an enormous pace, yet rarely hold many yen in their portfolio.
That means, among other things, that FDI inflows from Japan get turned into demand for euros and dollars by actors like the PBoC. Remember, China uses, in aggregate, net FDI inflows, to finance reserve accumulation, as its domestic savings is more than enough to finance its (high) level of domestic investment.
A lot of money has flowed into the euro and pound recently. I estimate that euro and pound reserves increased by close to $300b in 2005, and close to $200b in 2006. Those flows are one reason for pound and euro strength. Central banks looking for alternatives to the dollar have flooded into Europe — and shied away from Japan.
Chadha and Nystedt argue that this should change. The right time to buy euro was in 2001, when the euro was weak. Not in late 2004, when the euro was strong — or, for that matter, in 2007. By the same token, there has rarely been a better time to buy yen.
Sure, yen interest rates are low, but, over time, there is probably a greater chance that the yen will appreciate v. the euro than that it will fall even further. If your un-dollar choice is euro or yen, you currently can get a lot of yen for your buck, so to speak.
Chadha and Nystedt have suggested that central banks should buy yen in the past — a call that was perhaps a bit premature. I sympathize: my warnings about the US current account deficit were too.
But they also note that Asian regionalism should be good for the yen. If emerging Asia ever were to shift off a de facto dollar standard and truly manage its currencies against a trade-weighted basket, the flows into yen would be quite large:
"A move back by the Asian emerging markets to managing exchange rates against a basket of currencies and the likely use of such baskets for eventually evaluating reserve manager performance potentially imply very large shifts into yen reserves. Some countries have already begun to move in this direction and we expect them to continue to do so. If non-Japan Asian central banks start using their flow to diversify this could add appreciation pressure on the yen to the tune of ¥6.5 annually"
Even if central banks underweight the yen in their basket because of its low carry, they presumably wouldn't remain as underweight as they are now.
I tend to agree. This would be a good time for central banks to buy yen — central banks can diversify more easily when they go against the grain of the private market. They then are buying what the market wants to sell — not trying to sell something the market is already selling.
Worried about a loss of income from low yen rates? Why not throw a few Brazilian real into the mix? You would be adding claims on two current account surplus countries after all (here I am mostly kidding … )
The unpopularity of the yen as a reserve asset is but one example of how the fx policies of major governments are shaping global capital flows, and global financial markets. JP Morgan recently discovered that Asian equity market weakness is associated with Asian currency market weakness, but Asian equity market strength isn't associated with Asian currency stregnth.
Why? Because central banks intervene when the money is coming in, but not when it is flowing out (at least not currently). Malaysia is the latest example. India added $4b in the second week of February, after adding $5b in the first week of February. And Japan, obviously, has been far more inclined to intervene in the face of yen strength (and strong capital inflows) than in the face of yen weakness (and strong private outflows). Such assymetries add up.
I continue to be surprised by how comfortable so many in the private markets seem to be with a financial world — at least an international financial world – increasingly dominated by governments, not the autonomous action of private agents. The net flow of capital globally right now correlates more closely with the net flow of official capital than the net flow of private capital.
Private markets want to finance current account deficits in emerging markets.
As a member of the CBOT and a bond trader I am becoming increasingly disturbed by the amount of official participation in global capital markets. They are going to crowd out the private sector and eventually the global economy is going to be centrally planned. I feel Bill Gross frustration having to deal with governments who are using this system without regard for price. The refusal to let the markets adjust is disturbing.
From Barron’s Financial, the Great Unwind of Hedge Funds
” The ominous “Great Unwind” report was written by Stefan-Michael Stalman and Susanne Knips at Dresdner Kleinwort Wasserstein bank for Dresdner Kleinwort’s private banking clients; leaked sections of the report were covered in Barron’s on Feb. 12. The report’s assessment is stark: that the highly leveraged $1.3 trillion-in-assets hedge-fund sector, and its bank creditors, by following the practices of the deceased Long-Term Capital Management (LTCM) hedge fund, are headed toward a swift unwinding of its leveraged positions, which will result in a financial crash.
The report says that while the hedge funds control only 1-2% of all global assets under their management, they have contracted two-thirds of all worldwide margin debt (borrowing of funds for stock investment).
The authors warn that while it is made to appear “that hedge fund strategies across the industry [are] diversified, there is actually a high degree of correlation,” that is, most hedge funds are betting using the same strategy. This is exactly what LTCM did in 1998: It blew up. However, this time, the hedge funds have and are investing nearly 1,000 times the assets/money that LTCM had. “
Unlike the dual crusaders Batman and Robin, Paulson is flying into Beijing next week by himself, without his sidekick Bernanke.
Will Paulson’s next demand to the Chinese Central Bank be to ask them to buy all the subprime mortgage assets imploding the US “Bubble” Housing market?
Will Paulson kick Beijing butt, or should the Chinese kick his butt out of the country? Stay tuned for the next episode !
China and the ROW don’t care. They are just doing whatever they can to soak more dollars and make sure there currencies do not adjust. Thats the problem with a system dominanted by governments. Price and risk are irrelevant.
“autonomous action of private agents”
a misnomer at any time.
Brad,
One drawback to accumulating yen reserves, which seems likely to persist, is the relatively poor credit rating of Japanese government debt (which would be the type of instrument in which central banks tend to invest). The yen is the only significant reserve currency in which AAA/Aaa bonds are scarce.
I don’t agree with the assessment on the yen. BoJ hasn’t had great track record in economic management and is under too much political pressure to be independent. Similarly, I think the PBoC’s management practices are suspect. I am especially disturbed by the recent Chinese annoucement to set up a separate agency to invest reserves. With that much money flowing around, they could do great damage to any number of capital markets if they’re not careful. I still believe with US fighting 2 wars and spending now nearly $800B for Pentagon, dollar dominance will continue.
“…The interaction of these economic and technical changes has altered market valuations, volatility, velocity and liquidity. No wonder various markets seem to be sending conflicting signals…. market participants are having trouble predicting central bank policies… economists cannot resolve debates on the outlook forglobal payments imbalances… there is a sense that greater international co-ordination is needed even though the global economy is in the midst of an unprecedented phase of high growth, low inflation and greater economic and financial convergence. We should view these themes not as competing but as part of a fundamental change in the global economy. Consider five issues that face the public and private sectors…” http://www.ft.com/cms/s/7e2e6dc6-ac18-11db-a0ed-0000779e2340.html
Shrek,
I can see that the presence of investors that are price and risk insensitive might make markets more noisy, but except in the very short term, such irrationality ought to be good for a trader like you, and even better for a longer term player like PIMCO?
Governments are already major participants in the bond markets as the largest borrowers. Is it unreasonable for them to be major investors too?
“…the advantage to using EWJ to express the bullish Japanese equity view is that it contains a built-in hedge against yen strength. In the event of a rise in the value of the yen against the dollar, the performance of EWJ will be stronger than that of the underlying index of Japanese equities, since EWJ is a dollar-denominated instrument that tracks yen-denominated securities. Such a currency hedge could be especially valuable in the event of a global equity market correction…” http://www.forbes.com/home/guruinsights/2007/02/07/japan-ishares-economy-pf-guru-in_sd_0207soapbox_inl.html
Two things:
1. To be fair to Japan, it’s policy towards the yen at the moment is one of “benign neglect” instead of “active intervention” for obvious reasons. You can bet your, er, bottom dollar that the BoJ will change its tune when the yen falls below 110 (or even 115 probably). At the moment, regional beggar-thy-neighbor is in full effect.
The unpopularity of the yen as a reserve asset is but one example of how the fx policies of major governments are shaping global capital flows, and global financial markets.
2. Yes, Malaysia’s reserves may be going up, but is there proof that it’s actively selling MYR and buying USD in the open market?
“price and risk insensitive”
a bit of a misnomer as well? vastly different time lines, strategies, objectives, (feasible) options, instruments, capacities have to result in a broad range of interpretations and actions - none of which are completely insensitive to price and risk.
“Neovest, a New York-based provider of high-performance trading technology and direct market access, has announced that it now connects to 15 ‘dark pools’ of liquidity, trading networks that do not publish quotes in the open market…” http://www.hedgeweek.com/articles/detail.jsp?content_id=50408
‘They are going to crowd out the private sector and eventually the global economy is going to be centrally planned.”
‘centrally planned’ is yesterday’s term. we now call it ‘unipolar’ and mr putin speaks for a lot of people and countries who are not happy about it. whether communist or neoconservative, full spectrum dominance - or a one party state backed by surveillance imprisonment and torture - is an ugly thing to contemplate, to many of us.
nothing wrong with the chinese, the japanese, or the hedge funds - except that the capitalist game only works with a certain minimum number of players, nor must the players grow too big or the game doesn’t work.
Emmanuel, one can view a ZIRP in Japan as a form of intervention. And it hasn’t worked to reflate consumption in six years, yet BoJ doesn’t change policy. Until recently, and then only a little, and then with very public reluctance. Still digging that hole in which it stands, IMHO.
I certainly thought it was a good time to buy Yen a few months ago and plopped some savings reserved for speculation into an Everbank account. So far I’ve lost 5%, but I still think the upside is promising.
http://www.credit-suisse.com/globalstrategyblog
Why Worry?: “…a stylized picture of the global circulation of capital: Japan’’s surplus savings are chanelled (largely) via the private sector into (mostly) fixed-income-like assets in the US and some other parts of the developed world. Those investors, and especially the US private sector, with a greater appetite for and expertise in managing riskier assets, channel nearly as much money into FDI and equity investment in Asia (the workshop of the world). In other words, the US runs a huge current account deficit but still functions as an effective risk intermediary. Meanwhile, Asian central banks find themselves with spiralling reserves, which they invest (up till now) largely in (US) bonds, completing the circle.
This circuit can in principle be interrupted in one of four ways. First, the willing supply of Japanese savings could be cut off at its source. That’s precisely what didn’t happen this week when the BoJ raised rates. Second, Japanese investors might decide to invest more directly in Asia, reducing their purchases of developed world bonds. Third, the appetite for Asian FDI and equity investment among private investors in the developed world could suddenly collapse, as it did in 1997. And fourth, the smooth recycling of surplus reserves into (US) bonds could fall victim to a shift in investment preferences by Asian governments and central banks. (Which is starting to happen, but in practice the changes are likely to be implemented very gradually.)
This week’’s reaction to the BoJ rate hike could be taken, therefore, as a sign, that in the short term none of these three potential dislocations is about to take place. Longer term, however, all four of them remain in play: the question is why, when and how suddenly each one of these pillars of the current global money-go-round might crumble.”
i know that is considered a bit heretical in market circles, which view the US as super advanced and sophisticated and Europe as backwards, but the BoP data strongly suggests that Europe does way more risk intermediation than the US right now. Net fixed income flows to the US weren’t all that impressive in 2006 year (v. the US current account deficit), leaving a lot less spare cash to send to the rest of the world. indeed, the us current account deficit was only closed (in the data thru q3) with a big errors term providing a lot of financing.
europe, by contrast, attracted way more inflows than needed to cover its current account deficit. Sure, this is all on balance sheet — but the migration of financial activity to london and surge in european asset prices (and leveraged loan issuance and the like) provides some supporting evidence.
Today’s article by Peter Schiff:
Is the Fed Finally Losing its Credibility?
With Wednesday’s data release that showed that the increase in “core” CPI in January was higher than expected, the price of gold soared by over $20 per ounce to just shy of $680 per ounce, a new nine-month high. As this is the reaction that most market watchers would have expected, it is not surprising that these movements failed to inspire much interest. After all, gold is an inflation hedge, so any sign that inflation is worsening should be positive for gold prices. However, what is surprising is that this is one of the few recent occasions when the gold market has actually behaved logically in this regard. Could it be that some whiff of sanity has arrived on Wall Street?
Over the last few years, the price of gold has typically declined following larger than expected jumps in “core” consumer prices. These counter intuitive movements have been explained by the market’s anticipation that the Fed would react to higher inflation with additional rate hikes. Since higher interest rates are typically bearish for gold, the metal has dipped on signs of elevated inflation. However, Wednesday’s $20 surge indicates that something meaningful may have changed.
My guess is that the market is calling the Fed’s bluff. Gold investors may have finally concluded that when it comes to fighting inflation, the Fed is all bark and no bite. Despite the tough talk, many are now convinced that Bernanke will not risk pushing the U.S. economy into recession in an effort to contain inflation. With the sub-prime mortgage market unraveling, the last thing the Fed wants is to add kerosene to the fire in the form of higher interest rates. If gold investors now believe that the Fed will tolerate higher inflation, then any signs of heightened inflation can now be seen as purely bullish for gold.
This is an extremely significant development with profound implications for U.S. financial markets, particularly long-term bonds, the housing market, and the entire U.S. economy. If investors are finally wising up to the Fed’s bluster, a run on the dollar can not be too far off. To maintain international confidence in our currency, the Fed must be credible in its resolve to fight inflation. If our foreign creditors decide that “Helicopter” Ben is more concerned about keeping housing prices up than he is about keeping consumer prices down, they will rush for the exits.
I think we are fast approaching the time when the markets will actually force the Fed to show its cards. If gold prices continue to surge (up another ten bucks so far this morning,) and long-term interest rates finally follow suit, the Fed will be forced to make a very uncomfortable decision. It will either have to raise rates aggressively, and let the economic chips falls where they may, or fold its hand by leaving rates unchanged. Either way, we are in big trouble. If the Fed does the former, stock and real estate prices will fall, dragging the economy and the dollar down with them. If it does the latter, the dollar will collapse, long-term interest rates will soar, causing stock and real estate prices to plunge, and pushing the economy into recession. It’s the ultimate catch-22. When it comes to the Fed raising rates, we’re dammed if they do and dammed if they don’t.
On a somewhat related note, the current Wall Street bull market hype ignores the fact that all the major stock market averages are underperforming the price of gold. For example, year to date, while the Dow is up about 1.5%, the price of gold is up about 8%. Going back to January of 2000, while the Dow is only up about 15%, the price of gold price is up 150%, literally ten times as much. Even if you compare the Dow to gold starting from the Dow’s October, 2002 low of about 7,200, the Dow is up about 75% verses 125% for gold. Call me crazy but how can we be in a bull market if investors are making more money owning gold than owing stocks?
koteli, related to above, there was a sharp rise in my foreign currency bond funds this week, especially Friday. I don’t understand market timing, but I’d say it’s a shift in sentiment on which bonds to hold.
my (conservative) Cdn. gold equities have appreciated between 300 and 400% (without factoring in exchange rate gains), although I’m neither a buyer or seller of gold holdings at this time.
gold is still far from its all time high, (remember how far and fast it fell from that?) - even more so if adjusted for inflation. I agree with the idea that gold was responding more to the BoJ.
“Lehman Brothers Holdings Inc. says there is no immediate risk to profitably using the Japanese Yen and Swiss Franc for carry trade, the strategy of borrowing low- yield currencies to invest in high-yield ones. It suggested investors buy a combination of the Australian dollar, Canadian dollar, New Zealand dollar and Swedish krona against the franc and yen…” http://www.bloomberg.com/apps/news?pid=20601083&sid=aK9VDZtUH72U&refer=currency
I also have to wonder how much gold’s moves may be attributed to circumstances in India:
“…India is world’s largest consumer of gold at 800 tons per annum accounting for 20 percent of total annual global gold production…” http://www.fibre2fashion.com/news/fashion-news/newsdetails.aspx?news_id=30962
Any one notice IBN sank more than 5% yesterday alone?
re: “heretical in market circles, which view the US as super advanced and sophisticated and Europe as backwards”
“…Dominique de Villepin, prime minister, opened the school on Thursday, saying it would rival the world’s top institutions and allow “the construction of a French and European economic doctrine”… Thomas Piketty, the school’s director, told Le Monde that starting the project had been “like setting up Microsoft in the Soviet Union”…” http://www.ft.com/cms/s/7e1e4d7a-c373-11db-9047-000b5df10621.html
sorry to nitpik about the terms, but wondering about your definition of ’sophisticated’ and ‘europe’.
“…jurisdictions which favour non transparency and “discreet” banking, notably Switzerland, Luxembourg, Austria, Belgium and now, most recently, Lichtenstein, have concluded that the way forward under the EUSD..” http://www.maplesandcalder.com/index.cfm/fuseaction/library.viewitem/intitemid/479/view.htm
‘The State as Legal Fiction’: http://www.lancs.ac.uk/fss/law/intlaw/ibuslaw/docs/offshore.pdf
Brad,
I have a basic question on the whole carry trade discussion that took place on this blog a couple of weeks ago. Don’t like to post from work else would have asked this earlier.
I learned in Economics 101 that the capital account offsets the current account - so investors that borrow yen as part of the carry trade are in aggregate limited by the current account surplus that Japan runs, are they not? I’m sure I’m missing something here but would really like some clarification.
one of the problems for the yen as a reserve currency is that japan itself settles some 50-60% of its trade transactions in dollars. since so much trade now is with the rest of asia, that’s a testament to the dirty dollar bloc that asia has become. and it’s hard to see the yen, especially in china, taking on more of a role. do you think china would allow the yen to become asia’s main trade currency, even though the yuan has such a long road ahead in becoming convertible? and how is asia going to shift to asian currencies for reserves when they themselves are actively preventing their currencies from strengthening. no one seems to have noticed it’s been 3 years since japan last intervened and the current MOF has no desire to do so, unless there’s a real financial catastrophe going on that would probably involve more than just japan. anyway, talk of an asia currency unit is still very limited right now.
another thing, japan’s BOP data showed net portfolio outflows were less than inflows in 2006 — 9.2 trillion yen vs 22 trillion yen. in fact, the past three years they pretty much net out, with outflows of 52.8 trillion yen vs 64.33 trillion yen of inflows. the buying of japanese equities has been huge. but it seems a lot of those flows are getting hedged because of the yen’s weakness (and maintaining hedge ratios means selling more yen as it weakens via forwards/swaps/etc), while japanese foreign bond purchases are now mostly unhedged. especially the big purchases coming now from the investment trusts/mutual funds who don’t hedge (as opposed to the institutional money, which can’t now because of the inverted US yield curve).
From above:
” I learned in Economics 101 that the capital account offsets the current account - so investors that borrow yen as part of the carry trade are in aggregate limited by the current account surplus that Japan runs, are they not? I’m sure I’m missing something here but would really like some clarification ”
I’d be interested in the answer to this as well.
Also, I have a question of my own:
” Remember, China uses, in aggregate, net FDI inflows, to finance reserve accumulation, as its domestic savings is more than enough to finance its (high) level of domestic investment.”
Could you elaborate? Domestic savings in excess of domestic investment is a reflection of a current account surplus. If BoC were a typically functioning central bank, reserve accumulation would be functionally ‘financed’ by expansion of the domestic monetary base and/or domestic debt issuance. This is generic to central bank/exchange fund balance sheet operations, regardless of the source of the foreign currency. Where there is a current account surplus, these balance sheet operations can be viewed optionally as a recycling of some of the current account surplus. The fact that this component of domestic saving is then denominated in domestic currency is a consequence of these operations, not a cause for some other source of reserve ‘financing’.
I don’t see where FDI inflows come into it. What exactly is different in the way BoC operates?
“…global imbalances are offset by current account surpluses in some of the main emerging market economies where exchange rates remain undervalued, analysts Daniel Tenengauzer and Parag Ramaiya wrote in the report… Merrill said a current account deficit or surplus is not what determines the valuation of exchange rates. “What really matters is whether current account positions are too large or too small… It is possible to be bearish on currencies of countries with current account surpluses and bullish on currencies with deficits…” http://www.bloomberg.com/apps/news?pid=10000086&refer=latin_america&sid=ao3FHBBAI1OA
I think that the closer one is to bond and currency markets, the less comfortable one is with the role played by CBs. It has become a virtual cliche China, Russia, the Middle East, etc. have become price setters, rather than price takers, in bond and currency markets by virtue of such vast sums of capital that their flow becomes hegemonic.
I hear complaints like Shrek’s first post virtually every day; indeed, I am the author of more than a few of them myself.
Where it gets really tricky is with an institution like the BIS, which is simultaneously a regulator, a broker, and an asset manager. Barring effective Chinese walls, there is surely ample risk of impropriety within an institution that mixes those functions. The Larry Summers proposal of a central pool of passively managed global reserve assets makes a lot of sense to me in terms of minimizing market distortions.
Vis-a-vis the yen, I would concur that CBs probably should and ultimately will have a greater weight on yen in their reserve baskets. When this occurs, the yen will strengthen. A lot.
However, bear in mind that CB reserves are first and foremost meant to be a store of value. And on the basis of the past fifteen years, it is not at all clear to me at least that the yen can be trusted as a store of value for the next fifteen years. Ultimately, however, it will be in Japan’s interest for the yen to become a more prominent reserve currency, despite the concomitant rise in the exchange rate. This is simply because CBs could undertake to buy some of the enormous stock of government debt (assuming they are happy to have non-AAA rated paper), which will become susbtantially more costly to fund as Japanese interest rates normalize.
Again, though…I reckon Japan has to make it through a full economic cycle without receding back into crisis for the Voldemorts to keep comfortable with the yen as a store of value.
re: the carry trade. On a flow basis, yes, I think the increase in the size of the “carry’ trade ultimately is a function of Japan’s current account surplus. On a stock basis, it is limited by Japan’s cumulative current account surplus … or, put a bit differently, one the MoF stopped selling JGBs to finance the purchase of US treasuries (effectively acting as the investor who took Japan’s spare savings — the current accout surplus — and sent them abroad) in early 2004, private investors have been, by necessity, in equilibrium moving funds out of Japan.
that is one reason why some argue the stock of the carry trade now is big — sum up Japan’s cumulative current account surplus since early 2004, and it is starting to add up.
The twist is that the carry trade is usually thought of as a phenomenon involving debt. So if Japan is attracting net equity inflows (in Japan’s case, net inflows of portfolio equity), then debt outflows (call it the carry trade) will be equal to the sum of net equity inflows and the current account surplus. that is where definitional issues come up — is the carry trade just yen borrowed by leveraged/ speculative accounts, or do real money flows (debt purchases by japanese insurance cos) count as well.
tmchee’s data shows net portfolio (debt and equity) roughly cancel each other out - which implies large bank outflows (or large FDI outflows).
linking this up, i think one reason why there is more talk of the carry trade (apart from price moves that suggest yen selling) is that Japan’s current account is set to rise. the trade balance is growing (see January data), as the weak yen encourages exports and Japan’s commodity bill isn’t growing. and its income surplus should grow as well.
Re: FDI not used domestically. Guest — I am surprised this isn’t intuitive, since you seem to have a good grasp of a central bank’s balance sheet.
It is nothing more than an accounting identity — Reserve growth is equal to the current account surplus and net private capital flows. In China’s case, private capital is flowing into China (once you adjust for the PBoC’s swaps and various other manuevers to hold reserve growth down), largely (at least right now), because FDI inflows exceed FDI outflows. So by definition, part of the increase in the PBoC’s reserves will be financed by inflows from abroad.
Another way to look at it is that capital coming in from abroad (FDI or Debt) can be used either to finance a current account deficit (investment that exceeds savings) or to build up reserves. If it isn’t financing investment, by definition, it is going toward reserves (or various quaisi-reserve like funds).
A final way to look at it — say China is attracting 3% of GDP in FDI. That FDI is itself, obviously, invested inside China. But some domestic money that otherwise would go toward building a factory is freed up — and in China’s case, it is freed up to be lent to the central bank rather than invested in other projects. So if China savings 50% of its GDP and invests 40% of its GDP but 3% of that investment is financed by foreign money, 13% of domestic savings is freed up and not used for investment and instead lent to the PBoC to finance the expansion of its balance sheet. that total (13%) is bigger than the gap between savings and investment (10%) … ergo … the 3% inflow in some sense financed reserve growth.
hope that helps
Japan’s current account surplus is not really a constraint on the carry trade; its current account surplus may be expanded by the carry trade. The carry trade effectively involves a sale of yen debt (ie a bank loan is effectively a sale of unsecuritised debt by a borrower to a bank) for yen currency, followed by a sale of the yen proceeds of this sale for foreign currency. This requires a buyer of yen, either for investment in yen financial assets or to buy yen-denominated goods and services, with a downward adjustment in the value of the yen if necessary. Since the return on yen financial assets is held down by the Bank of Japan (which regularly buys yen debt for yen currency in its rinban operations), the yen is likely to be spent on goods and services (at least until their prices are lifted by this demand).
re Brad’s carry trade explanation: This seems to make sense since we are talking balance sheet changes it is the cumulative surplus that should count. However, intuitively there should be no limit on the carry trade as long as interest rates in JPY are relatively low.
RebelEconomist do you mean that the carry trade effectively weakens the yen thus leading to valuation gains (in JPY terms) on the cumulative current account surplus held in foreign currency and this valuation change effectively makes the cumulative current and capital accounts equal - from an accounting perspective that is.
Aditya
” Re: FDI not used domestically. Guest — I am surprised this isn’t intuitive, since you seem to have a good grasp of a central bank’s balance sheet.”
Thanks. That helps. I’m rusty on this stuff and may not have understood it properly in the first place. Plus I don’t really monitor China’s international balance sheet position.
But I think I understand what you’ve said. Private capital is a net flow inward to China, thereby exacerbating rather than offsetting the problem of deploying surpluses that begin with the current account but then include net capital inflows as well. The BOC must take up both.
Still, I’m confused because I read your piece as suggesting that gross FDI inflows must be taken out by the BoC because of this structure. If FDI comes in as U.S. dollars, cannot that flow alternatively be reversed by private buyers of U.S.? (e.g. the 3 % in your final example; e.g. through a U.S. dollar bank deposit in China.) This would not affect reserves. Domestic savings would be deployed privately through an effective reversal of gross inflows. Perhaps capital controls preclude this? Otherwise, it seems to me the cart is gross capital inflows and the horse is the BoC’s discretion in funding any part of this through monetization or monetization/sterilization.
I.e. doesn’t the BOC have full discretion over how much FDI linked foreign exchange it wants to monetize or monetize/sterilize? I’ve always viewed this part of central banking as a proactive decision rather than a reactive capital plug.
….
” Re: FDI not used domestically. Guest — I am surprised this isn’t intuitive, since you seem to have a good grasp of a central bank’s balance sheet.”
Sorry. On re-reading, looks like you are describing net rather than gross inflows. I’m there now. Thanks.
Guest at 10:43
I just meant that sometimes it is difficult to say whether the current account drives the capital account or the other way round. In this case, a carry-trade-induced yen weakening can be expected to increase Japan’s current account surplus.
Sometimes I think that the distinction between the current and capital accounts is not worth the trouble. After all, a piece of paper that generates a return (security) is not so different from a physical asset that yields a saleable product (a capital asset such as a machine). Given that the payments must balance (unless there is a net change in foreign exchange reserves), the inflow of yen debt assets from the carry trade must be matched by an outflow somewhere else, which could easily be in the form of current account items such as cars, laptops etc.
good news to my ears
“….the amount of official participation in global capital markets… going to crowd out the private sector and eventually the global economy is going to be centrally planned…”
even though i agree
“The refusal to let the markets adjust is disturbing”
Brad–I am quie sure that eventually the yen would recover and be held more by the central banks, particularly in Asia. However, the Japanese economy has just recovered from a long stagnation, and deflation has not yet fully overcome. In this situation, it is not unreasonable that the yen may be weak.
The current major misalignments of exchange rates are the euro-dollar rate and the dollar-renminbi rate; the euro has become too strong against the dollar, and the renminbi is too weak against the dollar. The problem is that neither Europe nor the US is inclined to intervene in the euro-dollar market, and the Chinese are determined to maintain a grossly undervalued currency with any means, including massive currency intervention.