Q&A: What's moving the Japanese yen?

Workers load a container ship in the port of Tokyo Is China playing currency games, or are Japan's exporters just victims of their own success?

Japanese exporters have good reason to grumble.

Their goods have become more expensive because the yen has risen to a 15-year high against the dollar, meaning the country's products cost more to buyers outside the country.

As a result, the central bank has stepped in to try and weaken the yen.

Why has the yen been rising?

A large part of the reason is that Japan's exporters have been a victim of their own success.

When a country like Japan - or indeed China - becomes a big exporter, it builds up big trade surpluses, because companies are earning more money abroad than foreign companies are earning in Japan.

That creates a steady flow of money into Japan. As Japanese exporters convert their earnings back into their home currency, this tends to push the value of the yen up.

But this is a very long-term effect, and does not explain all of the yen's rise in recent years.

How much has the yen actually strengthened?

The yen has risen most sharply since June 2007, gaining 50% against the dollar in that time.

The Japanese currency also strengthened significantly against other world currencies after the 2008 financial crisis.

Since July 2008, the yen has gained 58% against the euro and 50% against its neighbour, the Korean won.

Yen / dollar exchange rate The Japanese yen is nearing its 1995 all-time high against the dollar of 79.95 (the dollar buys fewer yen as the yen strengthens)

So this must be really hurting exporters?

Yes it is.

Many of Japan's competitors - like Germany or Korea - actually saw their currencies weaken against the dollar during the financial crisis.

But the picture isn't quite as bad as the exchange rate might suggest, because Japanese exporters have benefited over many years of falling prices in Japan.

This has pushed down their production costs compared to other industrialised countries, where inflation has typically been 2%-3%, giving them a competitive advantage.

So why is the yen so popular?

Normally, a weak economy and lower interest rates than the rest of the developed world would mean its currency was unpopular with investors.

But before the financial crisis took world interest rates to record lows, Japan was the cheapest place to borrow money.

Many speculators borrowed the yen, going on to invest in other currencies that paid a higher interest rate.

This so-called "carry trade" tended to push the value of the yen down.

But since the crisis, other countries - the US, the eurozone and the UK - also have near-zero interest rates, meaning that in comparison Japanese rates are not so exceptionally attractive any more.

When other world interest rates fell, carry trade investors bought back yen in order to repay their Japanese debts - and those purchases sent the yen higher.

But the rise in the yen in 2008 was also because it was seen as a safe place to park cash during the crisis.

This safe haven status was also apparent when the yen strengthened during the European debt crisis this summer.

So why have the Japanese authorities waited so long to intervene this time?

They have intervened in the past.

In 1999 and in 2004, the central bank sold yen and bought dollars - to stop the yen falling.

But the situation is now much more politically sensitive.

The US economy is struggling to recover, and Washington is not keen on other countries trying to weaken their currencies in order to gain a price advantage for their exporters.

The US government has been increasingly critical of China for exactly this reason.

Intervening in the markets is also not something to take lightly. Government authorities have to be willing to throw a huge amount of money at the problem.

Unlike China, Japan allows people to freely move money across its borders, which means that if markets decide to disagree with the Bank of Japan's view that the yen has peaked, then the Japanese will be fighting an expensive losing battle.

What have the Chinese got to do with all this?

China recently stepped up its purchases of Japanese yen, and has bought a record number of Japanese government bonds so far this year.

The Chinese central bank has already accumulated trillions of dollars in the US in order to stop the yuan from appreciating against the dollar, despite the country's enormous trade surpluses.

But now China is under political pressure from the US to stop buying dollars, so Beijing may have chosen to diversify into other currencies, including the Japanese yen.

This would tend to push up the value of the yen relative to the yuan, giving China what Japanese exporters may consider an unfair advantage.

It is suspected that behind the scenes the Japanese authorities were angry with China about this, although in public the Japanese finance ministry has said there is no problem.

So what might make the yen strengthen even more?

Here are a few things to watch for:

  • unexpectedly large trade surpluses in Japan
  • economic recovery or rising inflation in Japan, or further slowdown in the US and Europe - which means that markets expect higher interest rates in yen compared with dollars and euros
  • news that China intends to keep buying yen
  • renewed stress in global financial markets, which would make the yen attractive as a safe haven again.

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