Japan, here we come
Exploiting the undervalued yen
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.