Ja­pan, here we come

Ex­ploit­ing the un­der­val­ued yen

Finweek English Edition - - Creating wealth - BY VIC DE KLERK vicd@fin­week.co.za

AT A REAL ef­fec­tive ex­change rate of just un­der 70 (year 2000 = 100), the Ja­panese yen is cur­rently the world’s most un­der­val­ued ma­jor cur­rency. It’s just as un­der­val­ued as the rand was back in early 2002 af­ter the sharp fall in the value to about R12/$ ( Fin­week, 22 Fe­bru­ary, p 26) at the time.

The un­der­valu­ing of the yen – a phe­nom­e­non spread­ing to other cur­ren­cies such as the Chi­nese yuan – is partly the re­sult of for­eign-ex­change mar­kets be­com­ing rest­less.

The Bank of In­ter­na­tional Set­tle­ments (BIS) cal­cu­lates the real ef­fec­tive ex­change rates of 52 coun­tries on a con­tin­u­ing ba­sis by us­ing, among other things, the dif­fer­ence in con­sumer prices (in­fla­tion) to de­ter­mine the vari­a­tions in the ex­change rates. The pur­chase price par­ity the­ory states that the rise or fall of a coun­try’s ex­change rate must equal the dif­fer­ence of its in­fla­tion rate against the weighted av­er­age of its trad­ing part­ners.

Take Ja­pan for ex­am­ple. By the third quar­ter of 2000, the value of the yen was 101 against the US dol­lar. At the mo­ment, you need 116,5 yen to buy a dol­lar. But that’s not the end of the story. Be­tween 2000 and now, there was very lit­tle in­fla­tion in Ja­pan. In fact, con­sumer prices some­times even fell. With 2000 as the base of 101 yen for US$1, and the dif­fer­ence in in­fla­tion be­tween the two coun­tries over the six years, the dol­lar/yen ex­change rate should now be around 85 yen to $1. But it is 116,5 – and that af­ter the yen has strength­ened dra­mat­i­cally against the dol­lar over the past two weeks. The strength­en­ing is also the main rea­son for the cur­rent un­wind­ing of cur­rency carry trade.

Cur­rency carry trade is de­fined in In­vesto­pe­dia as “a strat­egy in which an in­vestor sells a cer­tain cur­rency with a rel­a­tively low in­ter­est rate and uses the funds to pur­chase a dif­fer­ent cur­rency yield­ing a higher in­ter­est rate. A trader us­ing this strat­egy at­tempts to cap­ture the dif­fer­ence be­tween the rates – which can be sub­stan­tial, de­pend­ing on the amount of lever­age the in­vestor chooses to use”. (See also the col­umn “The carry on cur­rency...” on fin24.co.za.)

While the US dol­lar has main­tained its value well since 2000 and is now at a real ef­fec­tive ex­change rate (REER) of 100, the euro has taken off com­pletely, and the eco­nomic re­gion where it’s used is bat­tling with an over­val­ued cur­rency that now has a REER in the re­gion of 128. When the rand was trad­ing at less than R6/$ last year, our REER was about 118. Even at that stage, the im­porters were wor­ried, while the im­porters were smil­ing broadly at all the cheap goods they could load up on the shelves.

To put the rel­a­tive val­ues bet­ter into per­spec­tive, we must look at what has hap­pened be­tween the euro and the yen over the past six years. In Septem­ber 2000, one euro could buy only about 90 yen. Now it’s worth 152 yen. That lit­tle Porsche that cost 40 000 euro in Europe in 2000 only cost 3,6m yen in Ja­pan. Now the Ja­panese have to cough up 6m yen for the car and have long ago de­cided against im­port­ing it. But there’s more to it. Think of the in­verse. Over the past seven years, Europe’s cur­rency strength­ened 60% against the yen, and prob­a­bly other Asian cur­ren­cies too, and now the re­gion is strug­gling to com­pete on world mar­kets. That’s just one rea­son for the woes now be­ing ex­pe­ri­enced by Air­bus, which is build­ing the world’s largest pas­sen­ger air­craft.

The graph, com­piled by BIS, will be use­ful for lo­cal im­porters and ex­porters. The cur­ren­cies of Asia, with Ja­pan at the front, are clearly un­der­val­ued. Un­der­val­ued cur­ren­cies usu­ally stim­u­late eco­nomic growth in the short term, while in the long term they’re al­ways go­ing to move back to the base of 100.

Ex­porters should there­fore now try to de­velop a mar­ket in Ja­pan and to in­voice their ex­ports in yen. The yen will strengthen and that will also give ex­porters a for­eign-ex­change profit.

The op­po­site is the case for the euro. Busi­ness is boom­ing in the re­gion, and Ger­many in par­tic­u­lar has ex­ploded as the coun­try with the largest trade sur­plus (US$206bn against the US$81bn of Ja­pan and the US$184bn of China). It was also fun to do busi­ness there over the past few years, be­cause the euro be­came in­creas­ingly stronger.

The cur­rent rand/euro ex­change rate of nearly R10/euro is within a few cents of the record lev­els of early 2002. In other words, the euro is al­most at a new record level against the rand.

But ac­cord­ing to the BIS’s REER cal­cu­la­tions, the euro is too strong, and this is per­haps not the re­gion to pick for new busi­ness. It’s bet­ter to look to the East.

How­ever, at a REER of just over 80 – and it has weak­ened even fur­ther over the past few days – ster­ling is quite un­der­val­ued against its Euro­pean com­peti­tor over the past six years. Ster­ling looks like a bet­ter bar­gain than the euro for lo­cal in­vestors who are still in­ter­ested in tak­ing a lit­tle money out of the coun­try for a for­eign nest egg. Ex­porters would also do well to look at this re­gion again. The REER of the rand is just be­low 100, while that of ster­ling is about 80. In the fu­ture, ster­ling must strengthen rel­a­tive to the rand or the rand must lose value against its old source cur­rency.

REAL EF­FEC­TIVE­TIVE EX­CHANGE RATES

Source: Bank of In­ter­na­tional Set­tle­ments (BIS)

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