G7 Nations Intervene In Currency Markets, Amid Concerns That Yen's Rise Threatens Trade

03/18/2011 08:31 am ET | Updated May 25, 2011

The yen fell against the dollar Friday, as the currency intervention announced Thursday night began, Reuters reports. Japan's central bank bought more than $25 billion, according to traders' estimates. Central banks in Germany, Italy, Britain and France prepared to contribute their support. On news of a coordinated intervention not seen since 2000, the yen fell against the dollar, and the Japanese Nikkei 225 stock index rose.


As Japanese factories and ports lie in ruins, a new threat to trade has emerged. The yen reached a record-high value Thursday, making exports more expensive and raising fresh concerns about the prospect of Japan's economic recovery.

Last Friday's 9.0-magnitude earthquake off Japan's northeastern coast has destroyed factories that produce goods for export, and it has ruined roads and ports that would otherwise be used to export those goods. Already, trade disruptions have prompted experts to downgrade their forecasts for the country's economy. Now, the outlook seems even worse: The value of Japan's currency has risen to a territory not seen since World War II, meaning the products that Japan does manage to export will seem less attractive to buyers.

Amid concerns that this development could affect economies worldwide, leaders from the Group of Seven industrial nations, in a release issued Thursday evening, pledged to support Japan's economy with financial intervention while declining to say what this intervention would entail. Starting Friday, the U.S., the U.K., Canada and the European Central Bank will join Japan in attempting to tame exchange rates, the U.S. Treasury said in the release. There seemed to be an acknowledgement that economic pain in Japan could be felt worldwide.

But the real strain, experts say, will be in Japan. The yen's rise could hardly be coming at a worse time for the country.

"It's one more blow to the Japanese economy," said Nariman Behravesh, chief economist of IHS Global Insight. "A strong yen is the absolute last thing they need right now."

Investors, expecting an expensive rebuilding process in Japan, are contributing to the currency's rise, experts say. To pay for damage claims and construction expenses, Japanese institutions will likely convert assets into yen, which would cause the value of the currency to rise. This process will likely be expensive, involving massive amounts of yen: Early estimates place the damage as high as 15 trillion yen, according to a Thursday report from Wells Fargo. That's about $190 billion.

In anticipation, investors are buying the currency. Those who had placed bets against the yen are now likely buying yen to protect against losses. Such trades help drive up the value of the currency, even before the rebuilding actually begins.

"Speculation is probably the most important element here," said Marc Chandler, global head of currency strategy at the financial services firm Brown Brothers Harriman. "There's been a huge jump in open interest this week. That would seem to imply speculators are buying yen, perhaps anticipating repatriation."

The yen has climbed 5 percent against the dollar since last Thursday's close, according to data provided by the website of the Financial Times. The yen achieved an all-time high on Wednesday, reaching its highest value since it was first tied to the dollar after World War II. The previous record, in 1995, occurred months after an earthquake struck the city of Kobe.

This new development doesn't bode well for Japan. The yen has been steadily increasing in value for more than a decade, as deflationary pressures have strained Japan's economy. When the yen is strong, goods shipped out of Japan become more expensive, and therefore potentially less attractive, for major trading partners like the U.S. In recent years, exports from Japan have been diminishing.

During 2010, Japanese exports measured in yen were 20 percent less than in 2007, according to Japan's records. During that period, the yen gained more than 30 percent against the dollar.

The yen's dramatic rise over the last few days could worsen that trend.

"That certainly increases the pressure," said Scott Anderson, senior economist at Wells Fargo. "It could magnify the downside risks for the Japanese economy in the second quarter."

In a report released Thursday, Wells Fargo slashed its forecast for Japan's economic growth. Earlier this week, the bank's economists expected Japan's gross domestic product to grow by 0.3 percent in the second quarter of this year, a revision down from an earlier forecast of 1.3 percent. But after new developments, those economists now expect the economy to shrink in the second quarter.

Before natural disaster struck, a recovery seemed to be underway. Japan's economy likely grew in the first quarter of this year, economists say, after shrinking at the end of last year. But now, that glimmer of hope appears temporarily extinguished.

A stronger yen means a weaker dollar, but experts said that wasn't a concern for the U.S. It could actually be slightly positive, as American goods become relatively cheaper abroad.

"It moves the needle a little bit away from Japan," said Gus Faucher, director of macroeconomics for Moody's Analytics. But he added that that's not necessarily a good thing for the world.

"Global trade in general is going to take a hit."