China’s ‘Midas touch’ drives yen to near all-time highs

China’s ‘Midas touch’ is driving the Japanese yen close to its all-time high, and Japanese policymakers, struggling to revive their faltering economy, may be more inclined to see China’s attention as a hindrance. Yet, policymakers seem conflicted on whether this is a blessing or a curse, and economists say they have good reason to be.

On Wednesday, the yield on Japanese 10-year bonds fell below 1% for the first time in seven years.

The yen is trading today at around 86 to the US dollar, within striking distance of its all-time high of 79.75, in 1995.

What’s driving the yen surge? The most proximate reason is Chinese accumulation of Japanese assets, say economists.
“In the first five months of this year, China amassed a whopping 1.3 trillion yen in Japanese assets (about $15 billion),” points out Moody’s Economy.com economist Matthew Circosta.

“That’s five times the amount it invested in 2005, and accounts for 23% of all portfolio inflows into Japan this year.”

According to Circosta, China is looking for somewhere to park its massive foreign currency reserve accumulations derived from keeping the Chinese yuan undervalued. “At a time when sovereign debt problems are depreciating the euro and a slowing US recovery is depressing the dollar, purchasing Japanese assets seems prudent at this stage.”

And it isn’t just Chinese buying that’s driving up the yen, although it is the most recent big buyer of Japanese assets. UK investors, the largest foreign holders of Japanese debt

UK investors — the largest foreign holders of Japanese debt — are on track to eclipse their 25.6 trillion yen investment spree last year. So far this year, they’ve pumped in some 18.3 trillion yen.

A strong yen is “salt in the wounds for Japanese authorities” who are trying to boost inflation expectations and support Japanese exports, the main driver of economic growth, notes Circosta.
“Pressure is growing on Japanese authorities to intervene in currency markets to weaken the yen and support exporters’ competitiveness. Policymakers’ attempts to talk down the currency certainly haven’t worked.”

Yet, other economists argue, for all the protestations coming from Japan, policymakers may not actively intervene in the foreign exchange market to rein in the yen - and, in face, may be looking to “take advantage” of a strong yen to advance their agenda.
“Bank of Japan officials seem to be keeping their cool regarding the exchange rate movements,” points out Societe Generale analyst Takuji Okubo.

“In our view, what lies behind such calmness is an expectation that Japanese exporters can cope on their own with the current elevated level of yen and do not need official intervention for now.”
In his estimation, a direct intervention in the forex market by Japanese authorities “seems highly unlikely” — even though the yen is approaching the level at which the Japanese government decided to intervene in 2003.

It isn’t only because any intervention in the forex market “is unlikely to be tolerated”, given that developed economies are down and out, reasons Okubo.

There is, he believes, “no apparent sign that the yen appreciation is deterring Japanese economy from its recovery
path.”

How else might policymakers respond? Okubo reckons that Japanese government officials are “taking advantage” of the yen’s strength to justify their taking on “accommodative fiscal policies”.

Following the ruling party’s defeat in Upper House elections, leaders, including the prime minister, may be backtracking from their earlier emphasis on regaining fiscal prudence.

“There is a growing appetite for fiscally expansionary measures to be taken towards the end of the year, and the emphasis on risks from yen