Lesson 2: A Traders Introduction to the Yen, Part II
Lesson 2: A Traders Introduction to the Yen, Part II
In our last lesson we began our discussion on on the Japanese Yen, with a look at the history of the Japanese economy, including the build up of what became one of the biggest asset price bubbles in history. In today's lesson we are going to continue this discussion by examining what happened from the early 1990's on from a monetary policy and economic standpoint, so we can understand the fundamental foundation on which the Yen sits today.
In 1989 the Bank of Japan (BOJ) began to raise interest rates, and the government instituted limits on total bank lending to the real estate sector, to try and reign in speculation which was driving stock and real estate prices to astronomically high levels. While the central bank was hoping to simply take the foot of the gas and tap the breaks on the economy, unfortunately the markets reaction was drastic, resulting in a stock market and real estate crash starting in 1990.
This was a "perfect storm" so to speak for the Japanese financial system and economy, as the effects of decline in real estate and stock market prices started a chain reaction, which reverberated throughout the economy and whole financial system. The first and perhaps most important thing to understand here, is that the economic slowdown, combined with drastic falls in the stock and real estate markets, caused the financial position of Japanese banks to rapidly deteriorate.
Much of the speculation that was sending real estate prices so high was being driven by loans from Japanese banks, which took the land they were making the loan on as collateral. As the quality of the loan was thus tied to the value of the real estate backing that loan, as real estate prices fell off a cliff so did the quality of the bank's loan portfolio's.
Secondly, large Japanese institutions such as banks cooperate with one another in Japan, and as a result of this Japanese banks hold large quantities of each others stock. Holdings of stock are considered an asset for the banks and were included in the banks capital numbers, which basically define how financially solid a banks balance sheet is. As the value of these stock holdings tumbled lower, so did the bank's capital position, putting further pressure on the stability of the individual banks in Japan, and the Japanese Banking System as a whole.
Thirdly, as the economy slowed as a result of all this, the individuals and corporations who had received loans began to have a harder time making their payments, further deteriorating the quality of the bank's loans, and stability of the banking system.
At least partially as a result of weak corporate governance, most will argue that Japanese banks did little to adjust to the financial difficulties they now faced, instead preferring to wait for stock and real estate prices to move back towards their pre bubble bursting levels. The government also did little to address the problem until 1995, when it became clear that without government intervention massive bank failures would result.
This history is important to us as traders for two reasons:
1. Reforms aimed at returning the stability of the Japanese financial system are still ongoing today, and it is these financial and structural reforms that traders watch closely when determining the fundamental direction of the Japanese Economy.
2. Japanese consumers, many of whom had lost large sums of money in the real estate and stock markets, lowered consumer spending significantly, resulting in prices actually starting to decrease towards the end of the 1990's, something which is known as deflation.
While many argue that the Bank of Japan acted too late they did eventually respond to the economic weakness with interest rate cuts driving interest rates in Japan down from over 8% in 1990, all the way to zero percent in 1999. While the Bank of Japan has increased interest rates in Japan to .5% since then, this is still by far the lowest rate of any of the the major economies of the world. As a result of this it is very cheap to borrow Japanese Yen, making it the primary funding currency for the carry trades, which we learned about in module 3 of this course. One cannot fully understand and anticipate movements in the Japanese Yen, without a full understanding of the carry trade, so if you have not do so already I encourage you to go back and review the three lesson series in Module 3 on the carry trade.
That's our lesson for today. In tomorrow's lesson we will wrap up our lesson on the Yen with a look at the history of Bank of Japan interventions in the currency market, and the major economic indicators which move the currency.
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WEEKLY Forex Economic Calendar: 28 Mar Tue
14:00 US- CB Confidence 29 Mar Wed
14:00 US- Pending Homes Sales
14:30 US- EIA Crude 30 Mar Thu
12:30 US- Weekly Jobless
12:30 US- GDP
23:30 JP- CPI 31 Mar Fri
7:55 DE- Jobless
8:30 GB- GDP
9:00 EZ- flash HICP
12:30 US- Core PCE Deflator
14:00 US- final Univ of Mich 2 Apr Sun
00:00 AU/NZ- Clocks "Fall Back"
Forex Market: items driving the market to start the new week:
Event Risk: The fallout from Heathcare fiasco last Friday has started to abate. The new focus is worry about the Trump economic agenda with getting legislative approval a growing issue.
Event Risk: A new Scotland Independence referendum will be considered by the Scottish Parliament today, while the May government will invoke EU Article 50 tomorrow (March 29). Last week's terrorist event could strengthen her hand.
There is a growing perception that the ECB might start to consider stepping back from excessive policy ease. Watch flash HICP data Friday. The March German Ifo Survey (Monday) was considerably stronger than expected and will be noted by the ECB.
Lots to consider. Please comment...
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