As this currency is making the headlines, and is of course one of my favorite currency to watch, I thought it could be a good time to write a bit of its history (devaluation, appreciation…) especially since the ‘collapse’ of the Bretton Woods system back in 1971.
Firstly, the Yen was introduced in May 1871 by the Meji government with the enactment of the New Currency Act. It replaced the Edo period (1603-1868) monetary system, which was based on a three-coin system (gold, silver and sen) where each feudal domain Han could issue its own currency called the Japanese Hansatsu (type of banknote, vertically printed and narrow).
After a few devaluations that impacted the value of the Japanese Yen (against the dollar), Japan eventually adopted a Gold Exchange Standard in 1897 and froze the value of the Yen at $0.50. The currency started to depreciate [once again] after Japan left the GES in December 1931, evaluated $0.30 until the start of WWII.
There are no historical value of the Yen during the Second World War, but the currency lost most of its value during and after WWII and was finally pegged at 1 USD = 360 JPY in April 1949. That rate remained unchanged until the United States abandoned the gold standard (Nixon Shock in 1971), effectively ‘ending’ the Bretton Woods System. As the Yen had become undervalued during those two decades, the current account switched from deficits in the early 1960s to a large surplus of $5.8bn in 1971. Therefore, under the post Bretton-Woods Smithsonian Agreement in December 1971, USDJPY was devalued to 308 Yen and allowed to fluctuate within 301.07 and 314.93 (a 2.25-percent trading band as a result of the US pledging to peg the USD at $38 per ounce with 2.2.5% trading bands)
The End of Bretton Woods
Then, in March 1973, the Japanese monetary authorities decided to let the yen float freely against the greenback in the ‘new’ system of floating exchange rates. As you can see it on the chart, the Japanese Yen rapidly appreciated against the US Dollar and hit a high of 254.50 in March 1973 (despite a government constantly intervening in the FX market) before coming back above the 300 level. The ‘come-back’ to the 300 level is explained by the impact of the 1973 oil crisis. In fact, as the Japanese economy was dependent on imported petroleum, the surge in oil prices (OAPEC countries proclaiming an oil embargo in October 1973 to countries supporting Israel in the Yom Kippur war – Japan was on the list) led to severe inflation (Annual 25% in February 1974 according to trading economics) resulting to a Yen sell-off between 1974 and 1976.
The rapid recovery of the Japanese current account from 1976 to 1978 (see appendix 1) led to another sharp appreciation of the Yen and the pair pushed through the 200 level and hit a new low of 177 in October 1978. As you can see, the trend was again reversed due to the second oil shock in 1979 (OPEC Libya and Indonesia announced plans to raise the price of their oil by $4 and $2 respectively, leading to the highest prices ever), and the Yen experienced another weak period with USDJPY sold to 250 by the end of 1979.
During the 1980s, Japan started to record increasing current account surpluses but the country’s currency failed to appreciate as the strong demand for yen in the FX market was offset by other factors such as the interest rate differential (US FF rate much higher than Japan BoJ discount rate) and of course the financial and capital account liberalization. With lower capital controls, Japanese investors were able to change their Yen in other currencies (USD mainly) and invest internationally, therefore increasing the supply in Japanese Yen and boosting USDJPY.
The 1985 Plaza Agreement and US Dollar devaluation
An important event that occurred in mid-1980 was the Plaza Accord signed by five governments (on Sep 22, 1985) – France, West Germany, US UK and Japan – to depreciate the US Dollar in relation to the Japanese Yen and the Deutsche Mark. If you have a look at the appendix 2 that shows US current account (as a share of GDP), you can see that the US competitiveness deteriorated in the 80s, therefore this could be one of the main reasons why the dollar was judged ‘overvalued’. The consequences were brutal and USDJPY pushed through the 200 in the following months to hit a low of 192 in January 1986 from September’s high of 244 (equivalent to a 21-percent devaluation). By the end of 1988, the pair was trading at 120, 50-percent lower than when the Plaza Accord were signed.
A cross in interest rate differential….
Between 1989 and 1992, while the US decreased their FF rates from 9.75 (May 1989) to 3% (Sep 1992) due to the Savings and Loans crisis, Bank of Japan started a tightening cycle at the same time and raised its interest rate from 2.5% to 6% in 1990 to counter the explosion of real-estate transactions and high stock prices (Nikkei 225 surged from about 13,000 at the start of 1986 to hit an all-time high of almost 39,000 at the end on December 29, 1989), adding on the top of that restrictions on the total volume of real-estate lending (Soryo-kisei) causing a drop in the availability of credit. The ‘cross’ in the interest rate differential should also have played in favor of the Yen during the first five years of the 1990s; USDJPY hit a low of 79.70 in April 1995.
The BoJ response and the Yen carry trade
By switching to a ZIRP policy – BoJ dropped its benchmark rate to 0.50% by 1995 – in order to stimulate the economy (after the equity market collapsed by 64% to 14,000 in Sep 1995), USDJPY shoot gradually to 147 by the end of the summer 1998 partly due to Yen carry traders, a strategy in which investors borrow yen funds (at zero interest rate) to buy higher-yielding currencies.
LTCM: Risk-OFF mode and carry unwinds
Russian default in August 1998 (due to two external shocks – Asian financial crisis and the decline in demand for crude oil) quickly followed by the failure of the LTCM triggered a risk-off environment. Carry trades were unwound and USDJPY tumbled to 111.50 within a few weeks. Despite repeated interventions from the BoJ, the pair couldn’t find any support and was sold to 101.30 in January 2000.
After that, in the early 2000s, low rates set by the BoJ discouraged investments in Japan and favored carry trades due to the cheap funding costs of the Yen. After the Japanese currency suffered from another sharp appreciation between February 2002 and November 2004 (one explanation: bearish USD during the war in Iraq) to retest a low of 102, we entered a new bullish trend with the pair appreciating by 25% before the GFC emerged. Our favourite AUD/JPY levitated from 80 to 108 during the same period, and almost doubled in value between October 2000 low of 55 and July 2007 high of 108.
GFC consequences: the Yen appreciation
After hitting a high of 124.15 in June 2007, USDJPY fell sharply to a low of 75.55 in February 2012, killing Japanese exports (as firms lost their competitiveness), causing stock prices to decline and plunging the country into a negative spiral (Japan’s debt surged from 167% of GDP in 2008 to 230% in 2013). Annual inflation plunged back into the negative territory in early 2009 (making it difficult for the country to deleverage their debt, making it unsustainable), the balance of trade started to show red figures (i.e. deficits) also in early 2009 before shifting definitely back in the red territory (as of September 23rd 2014, 26 consecutive months of trade deficits) threatening investors that Japan may also report a negative current account after 30 years of CA surpluses.
Abe’s three arrows, Japan’s last hope?
I explained in my 2014 outlook (Abenomics: a speculative story to continue) Abe’s goal to revive the Japanese economy with the so-called three arrows. At that time, I felt surprise (and ‘shocked’) that an economy that represents the third of the US economy announced that the BoJ was going to double its monetary base (buying 70tr Yen worth of bonds, almost the same size as the Fed’s 85-billion QE3 at that time) in order to reach a two-percent inflation rate (think about the expansion of the balance sheet as a share of GDP, see article It is all about CBs…). The Yen is now up 43% since November 2012, and recently pushed a couple of main events:
- BoJ late announcement: a couple of days after the Fed announced the end of QE3, the Bank of Japan took over and raised, by a 5-4 majority vote, its bond-buying program from 70tr to 80tr Yen (and tripled its purchases of ETFs to 3tr Yen). Just a few days after Governor Kuroda’s confusing speech (‘BoJ isn’t trying to cause negative rates’, ‘BoJ trying to use easing to lower yields overall’ and ‘negative rates in market reflect BoJ’s strong easing’), the market was surprised on that reaction.
- Reuters’s leak that Japan is more likely to delay sales tax increase that was planned to be increased by another 2% to 10% next October.
After all, it is clear that the BoJ is doing ‘whatever it can [and takes]’ to boost the Japanese economy after the so-called ‘two lost decades’, but traders’ question now is where do they see USDJPY heading. After reaching the 115 level, is 120 the new retracement that the market will target?
Summary of the Yen’s history in the chart below
(Source: Trading economics)