Currency sterilized intervention & non sterilized intervention

During MBA international finance class, we have been discussing sterilized intervention & non sterilized intervention. We can take it easy by relate the word sterilize as a small sterilization pill used by rapist to rape and sterilize their victims. Sterilize means that to stop the productivity, without increasing in supply of something, it can be pregnancy, bacteria, in this term it mean money supply in the market.

There are basically two types of intervention: sterilized and unsterilized. Sterilized intervention requires offsetting intervention with the buying or selling of government bonds, while unsterilized intervention involves no changes to the monetary base to offset intervention. When intervention is not sterilized, the money supply is increased because the funds used to sell yen may be raised by printing money.

We can understand more deeply currency sterilized intervention by read this paragraph.>>> [The central bank “remains prepared to buy foreign currency in unlimited quantities” to hold down the franc, Thomas Jordan, the Swiss National Bank president, said at a news conference in Bern, according to a text of his remarks. “Even at the current rate, the Swiss franc is still high. Another appreciation would have a serious impact on both prices and the economy in Switzerland. The S.N.B. will not tolerate this.”,(Source: http://www.nytimes.com/)]

History of Currency Interventions in Japan (Source: Deja vu – Another Currency Intervention in the offing?)

From 1989 to 2003, the Japanese economy was suffering from a long deflationary period. On June 2003, over a 15 month period, the Japanese central bank intervened in the YEN/USD currency markets by injecting over 35 trillion Yen of currency. This currency was then used to buy 320 billion U.S. dollars, which were in turn invested into U.S. treasuries. The jury is still out on whether this increased yen supply did actually weaken the yen against the dollar or not.

Tokyo also intervened on September 15, 2010 shortly after the dollar hit a 15-year low of 82.87 yen, a move that pushed the U.S. currency up by more than 3 percent during the day. While the dollar rises soon petered out, finance ministry officials judge the intervention as a success as it halted excessive, short-term falls and prevented the U.S. currency from breaching the psychologically important 80 yen level. It took another six months for the dollar to eventually cross that line.

The next round of FX intervention came in March 2011. After the tragic earthquakes and nuclear crisis that crippled the Japanese economy, Yen appreciated to a new high of 76.25 (I will discuss the reasons for this appreciation in the next section). Not only was that a damagingly high level for Japan’s export-led economy, it also risked triggering the “volatility” in currency markets that central bankers hate to see. So, for the first time in more than a decade, central banks around the world stepped into the foreign exchange market and jointly intervened to sell the Japanese yen.

The last time all the G7 central banks had acted together was in September 2000 then the euro fell to a record low.  At the time, the Federal Reserve, Bank of England (BOE), Bank of Japan (BOJ) and other central banks joined the European Central Bank (ECB) in buying Euros.

Let us now analyze the various external factors which lead to an appreciation in Yen.

Factors influencing the value of Yen –

Japanese Yen has a few unique characteristics which make it vulnerable to such extreme moves every now and then.

Safe Haven –

Traditionally, the Yen has been considered as a safe haven for investors. So whenever there is some kind of an economic crisis, there is a flight to Yen from other currencies. At the moment, the European crisis and the US debt drama have shaken investor confidence in Euro and Dollar, leading to a surge in demand for the “safe” Yen.

Unwinding of “Carry-Trade” –

Carry-Trade is a popular investment strategy in which traders take advantage of ultra-low interest rates in Japan, by borrowing in yen and reinvesting the proceeds in some other, faster-growing stock market overseas – exchanging the yen for Brazilian real, New Zealand dollars, and so on.

Nervous investors may have started to reverse this bet in recent days, bringing their overseas investments back home, and strengthening the Japanese yen in the process.

Repatriation of Cash –

An important reason for the unprecedented yen appreciation post the March earthquake was that Japanese insurance firms and other corporations were “repatriating” cash – exchanging their foreign-denominated holdings for yen – to pay for the cost of handling the crisis.

“Good” old market speculation –

A very depressing reason for the yen’s move could also be pure speculation — investors betting, George Soros-style – though these days through complex financial instruments – on how the yen would move as a result of the crisis. Japanese deputy finance minister Fumihiko Igarashi said that these speculators are ‘like sneaky thieves as the scene of a fire’, who are capable of ruining the Japanese economy.

Impact of a Stronger Yen on Japan and the rest of the world –

A stronger Yen is bad news for the Japanese economy since it is heavily dependent on exports for generating even the meagre economic growth of the past few years.

The wrenching aftermath of the collapse of Lehman Brothers collapse in autumn of 2008 showed that rapid movements in financial markets can very quickly transmit panic throughout the global economy. If the US defaults or the European crisis gets uglier or the carry trade is abruptly unwound, it could cause what economists call a “sudden stop,” draining capital from riskier markets around the world, with real consequences for business and consumers on the ground.