The G7 and Japanese Currency Markets

Japanese yenThe G7, a loose association of the world’s seven wealthiest countries, took the unusual step yesterday of backing intervention in Japanese currency markets. In the aftermath of the devastating earthquake and tsunami, the value of the Japanese yen had been pushed to record highs by markets (and currency speculators) anticipating Japanese companies repatriating funds to help rebuild lost production capacity. In hopes of keeping its currency value stable, the Japanese government injected 60 trillion yen (more than $740 billion) into the economy over a four day period following the crisis. But despite these efforts the yen climbed to its highest levels since World War II last week, peaking at 77 yen per dollar last week.

So what’s the worry? Currency values are important in determining exports, imports, and balance of trade. In general, a weaker currency means more competitive exports. This is why countries sometimes risk the specter of competitive devaluation, as the United States has accused China in recent years. But in the case of the Japanese yen, the challenge is much greater. An increase in the value of the yen could weaken the Japanese economic recovery. But more importantly, there was concern that it could also hamper the rebuilding effort by sapping much needed wealth from the market.

Historically, the G7 (as well as its individual member states) have been hesitant to intervene in foreign exchange markets, guided by the perception that it simply doesn’t work, or that the dangers outweigh the possible benefits. This is why the G7 maneuver is so unusual.

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