In the end, Japan's decision to wade into currency markets to dampen the soaring yen was a matter of a beleaguered government keeping its promise. The move worked, for a day. But such costly unilateral interventions rarely succeed in reversing the direction of a freely floating currency for long, if history is any guide.
The Bank of Japan managed to pull the yen back from a 15-year high against the greenback at an estimated cost of $20-billion (U.S.). But it may have to spend ever higher sums to keep a lid on the currency, particularly if other central banks maintain ultralow-interest-rate policies. Because of deflation, Japan actually has high real interest rates by comparison with other major industrial countries, and that will keep attracting investors to yen-denominated bonds.
Prime Minister Naoto Kan had promised that his government would take strong action to halt the yen's rapid appreciation, which was hammering exporters and darkening an already gloomy economic outlook. But after he fended off an internal challenge to his leadership of the ruling Democratic Party of Japan from rival Ichiro Ozawa, who was much more hawkish about intervention, currency traders bet that the government would not step in.
As a result, the yen grew even stronger, finally forcing Mr. Kan's hand.
Some analysts argue that the move will succeed, because the yen was already overvalued. Several havebeen forecasting a weaker yen by the end of the year, without any government interference.
"Japan's current 'big-splash' intervention approach is likely to succeed," Goldman Sachs said in a note to clients. "Big splash interventions rarely create tensions with the governments of other countries. The primary aim is to change biased perceptions or to slow disruptive price action."
Nevertheless, Goldman says more interventions are likely.
And other analysts argue forcefully that this will accomplish nothing, beyond depleting Bank of Japan coffers or forcing it to crank up the printing presses.
If Japanese policy makers learned anything from their last efforts to bring down the high-flying yen in 2003 and 2004, it would have been "the folly of unilateral currency market intervention," Carl Weinberg, chief economist of High Frequency Economics, wrote in a note to clients. The central bank intervened for five consecutive quarters. When the government finally gave up the battle, "the net effect of nearly $300-billion worth of currency purchases … was nil … and the central bank lost its shirt being long U.S. dollars."
The underlying causes of the strengthening yen are not about to disappear any time soon, even though the country's economic prospects are less than rosy.
One reason is that Japan's continuing trade surpluses and relatively high domestic savings rate make it one of the few providers of global capital. And its currency continues to be viewed, along with the Swiss franc and U.S. dollar, as a safe harbour in a sea of deepening investor uncertainty.
Also, Japan's aging population means steadily falling consumption and hence declining imports. Combine that with steady exports and the result will be balance-of-payments surpluses for years to come.
The Japanese hold a lot of foreign assets, including bonds and equities. But some of this capital is being repatriated, in part to cover growing pension obligations.
"This year, the national pension system will pay out more than it takes in, and the payouts are in part being generated from the liquidation of foreign investments," said Ken Courtis, founding partner of Themes Investment Management in Hong Kong and a long-time Japan watcher. "This particular buying force will become stronger and stronger during the years ahead."
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Try, try again
Some previous currency interventions
2010 - Swiss National Bank buys vast amounts of euros to stem the franc's rise, to no avail. The franc reaches an all-time high against the euro in July, and the central bank begins selling some of its euro stash, driving the franc even higher.
2009 - Russia dips into huge foreign exchange reserves and spends more than $200-billion (U.S.) to shore up the ruble against euros and dollars. It doesn't work.
2003-04 - Japan spends more than ¥30-trillion ($350-billion) to drive down yen's value, largely without success.
1992 - Britain attempts to rescue the beleaguered pound, but fails to stop the speculative tide of selling. Currency speculator George Soros makes a tidy profit of $1-billion and becomes world famous, while the pound is driven out of the European system of linked exchange rates.