Kristina Hooper, CFP®, CAIA, CIMA®, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Japan's bold economic stimulus agenda has turned some heads, prompting some central banks to intervene in an effort to counter currency appreciation. Cutting interest rates and devaluing currencies are further signs that financial repression as a policy tool is spreading.
A long time from now, when financial historians write about this period of unconventional monetary policy, they may point to May 9, 2013 as an important date. That's the day that the US dollar rose above 100 yen for the first time since April 2009. It's a day that has been anticipated since November 2012, when the market began discounting a new prime minister, Shinzo Abe, and a dramatic shift in monetary policy. And it's a day that's been a long time coming: Japan's response to extreme monetary measures taken by the Federal Reserve and other developed nations to recover from recession.
Turning on the Tap
To understand the significance of last Thursday, let's go back in time to the global financial crisis. Many developed countries embarked on financial repression through quantitative easing during that period in an effort to stimulate their economies. One notable exception was Japan. While Japan began quantitative easing well before other developed nations, it was a more moderate approach. That's why the yen began rising in value relative to the dollar four years ago.
Since the Bank of Japan announced its aggressive monetary policy stance on April 4, embracing financial repression and dramatically expanding its level of quantitative easing, the yen has continued the fall it began in November. As a result, the US dollar has been flirting with the 100-yen mark. However, the dollar did not rise above 100 yen until Thursday, presumably helped by stronger-than-expected US jobs data. The drop in the yen is the result of Japan's long-awaited policy response to the QE policies of the Fed, the European Central Bank and the Bank of England. For Japan's long-suffering economy, embracing financial repression means a devaluation of its currency and the potential for greater exports. A more favorable exchange rate is likely to get things moving in the right direction after several years of currency headwinds.
When you think about what determines exchange rates, it starts with a discussion of supply and demand. And demand is dictated by several factors, most notably a country's interest rate and its inflation expectations. The QE policies intended to stimulate economies also can raise inflation expectations. Higher inflation expectations not only encourages savers to spend more—because their money will be worth less tomorrow than it is today—but also it brings about a faster adjustment of real exchange rates relative to emerging markets than one might expect. Why? Because inflation expectations are so low for many developed nations.
Choking Off Yield
With higher interest rates and higher inflation expectations, it's no surprise that currencies of many emerging-market nations are more highly valued. For example, many Asian nations have struggled with an influx of foreign capital flows, as investors chase the higher interest rates they offer. This is a direct effect of financial repression, which has caused many developed countries to lower interest rates to artificially low levels, choking off many sources of yield and forcing investors to countries with higher relative interest rates (largely developing countries.) In fact, gross capital flows to emerging markets are up 42% to $64 billion since last April, according to the World Bank.
Of course, many emerging-market countries would like their currencies to devalue in relative terms so that their goods are more attractively priced to foreign consumers. They are looking longingly at Japan, which appears poised to reap the rewards of its currency devaluation. A sharply weaker yen will likely enable at least some of the country's leading automotive and electronics companies to report stronger earnings and raise their future outlooks. Conversely, countries like South Korea are suffering. The South Korean won has risen 24% against the yen in the past six months, hampering its competitiveness relative to Japan in the export of cars and electronics.
It's no surprise, then, that we've seen so many interest-rate cuts by emerging-market economies in the past several weeks. India, Poland, Sri Lanka, Vietnam and South Korea have all cut their interest rates in an attempt to counter currency appreciation. Even developed nations that vowed not to intervene in their currency's valuation are having second thoughts. For example, Sweden, which exports a substantial portion of its economic output, said the krona's appreciation may warrant central bank intervention. Financial repression has a way of pulling more and more countries into its tight embrace.
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