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Japan Study

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The Yen, denoted by JPY is the official currency of japan. Third to the Euro and the US dollar, it is the most traded currency in the foreign exchange market. In effect, though forces of demand and supply in the market would normally determine the market trading interest rates, Japan depends on the Japan Ministry of finance to set the exchange rate policies for that matter. These interest rates set by the Bank of Japan Policy Board have a very high influence on the exchange rate of the Japan national currency. Hence, they affect the yen assets since a rise in the interest rates leads to a higher return from the assets, thus leading to an appreciation of the currency value. On the other hand, it negatively affects the export side of trade (EconomyWatch, 2010).

In a summary, since Japan does not have oil deposits, it entirely depends on imported crude oil. As a result, the country is highly affected by crude oil prices. Furthermore, the country mostly depends on its exports for foreign trade, therefore any increase in prices of its imports negatively affects the Yen value. Another observation from an edition by EconomyWatch is that Japan is somehow poor at foreign trade, which results in low productivity of domestic companies. Thus Japan’s Yen did not get to be widely traded across the globe initially, thus making it very weak in the foreign exchange market. Effectively,  if the value of the yen goes very high investors would prefer to invest in other low-cost nations because trading in Japan would be more costly, being one of the factors that affect Japan’s currency.

One thing that most traders do is to anticipate trends. It is not actually a guarantee of better results, but it gives an overview of expected performances and returns. No wonder, successful businessmen admit to the fact that initially they had observed the trends of a series of occurrences before arriving at their decision to do business in a certain way. Similarly, the yen has exhibited a certain chain of trends over the years as this paper will illuminate. First, William Tsutsui in his book explained that initially, in 1949, that Japan Yen was pegged to the US dollar at 1 USD = Yen 360 (2009). It was maintained at this level for about twenty-two years and had significantly enhanced the economic growth for that period. After the Bretton Woods system collapsed, Japan government adopted a floating exchange rate system, which is controlled by forces of demand and supply in the market. Consequentially, during the postwar period the Japanese monetary policy somehow remained the same, which means that “the undervalued Yen remained undervalued” (Brawley, 2005). Brawley adds that this helped to make the Japanese exports competitive and “the plaza accord marked the beginning of a big change in Japanese policy. Japan became more active and began to support the appreciation of the Yen relative to other currencies” (375).

            In early 1980s, Japan had not altered its previous monetary policies. Brawley says that Japanese intervention never included any significant purchase of the dollar. This was because the U.S. monetary was that of ‘benign neglect’ while that of Japan was unilateral, which caused the Japanese Yen to remain weak against the U.S. dollar, hence failing the high expectations of the floating exchange rate by the Bank of Japan (2005). The bank governor showed a sense of disappointment in the county’s monetary policy instigating that it needed some change in order to increase the yen value. However, this was not received nicely by the U.S. government due to fears that the Japanese yen would grow stronger than the dollar, while at the domestic level it also received opposition from a group of Japanese who thought that the international policies had built up the country’s financial reserves, which expanded exports. They felt that a lower value yen was appropriate for Japan because it increased the value of its exports. Nonetheless, during the phase of 1971 – 1985, sources show that the Japanese yen had been appreciating constantly without any fluctuation in trend (EconomyWatch , 2010). However, despite these repulsive factors, after implementation of the Plaza Accord of 1985 the Japanese currency strengthened, thereby enabling the country to invest abroad and to tap more offshore markets. In turn, this depressed industrial growth and employment at the domestic level. It led to reduced investment at the domestic level thus leading into deflation of the economy, which forced the government to intervene in the forex market in order to combat side effects of the yen appreciation.

Briefly, in analyzing exchange rate trends, economists use two theories to explain and predict exchange rate trends over the long run. These are ‘the purchasing power parity theory’ and the ‘monetary approach’. The purchasing power parity theory’ stipulates that the exchange rates tend to harmonize values of different currencies so that someone may be able to purchase a given product at a given price that is similar in value across different currencies. By this, if he or she would need 1 U.S. dollar to purchase a loaf of bread in one country, then in japan he or she would need a yen value that resonates with that at a given date. This concept is only applicable in an efficient market and for internationally traded commodity. Additionally, applying this theory illuminates the fact that relatively high inflation in one country will cause currency to depreciate in the long-run. No wonder, deflation in Japan was the actual cause for appreciation of its currency over time.

Secondly, in the same light of monitoring trends of currency is the ‘Monetary approach’, which looks at the long-term money supply of two or more nations. This form is built on the quantity theory of money, which states that if a county increases its supply of money faster than its rate of change in real GDP then prices will definitely rise. As a result, the county’s currency will depreciate in value according to the foreign exchange markets. On the other hand, if the country increases its money supply at a rate that is less than the real GDP, the currency will appreciate, as is the case with Japan’s currency.

In conclusion, according to this approach, if the country maintains a restrictive monetary policy and increases its rate of production then the currency will appreciate. Japan’s currency has been appreciating constantly for many years now, from 0.00840195 USD against 1 JPY in 2007, to 0.00895175 USD against 1 JPY in to 2008, and to 0.0110144 USD against 1 JPY, and so forth. This was only over a sample period of three years from 2007 to 2009 as shown from a graph by EconomyWatch (2010). From this, it is very clear that the data supports the monetary approach theory since the yen constantly showed an appreciating value against the U.S dollar. Nonetheless, Japan maintained a restrictive monetary policy and increased its rate of production, which resulted into appreciation of the yen.

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