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Japan's currency has surged to its highest level in almost 16 years, further straining an economy in crisis.

The yen gained as much as 0.9 per cent to 79.98 per U.S. dollar Wednesday as currency traders speculated that the Japanese government, insurers and other companies will have to repatriate billions invested overseas to pay for rebuilding. Some estimates now peg the cost of the devastating earthquake, tsunami and continuing nuclear emergency at more than $180-billion (U.S.).

A major withdrawal of Japanese offshore investment would harm asset values and threaten the nascent recovery in Europe and North America, where governments have borrowed heavily to prop up their own economies.

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In 1995, Japanese investors sold a record $30-billion of U.S. securities following the Kobe earthquake, equivalent to 13 per cent of Japan's Treasury holdings at the time.

Stéfane Marion, chief economist and strategist at National Bank Financial Inc., expects even broader selling by Japan this time if damage estimates are accurate.

"The U.S. Treasury market would not be immune to a large wave of capital repatriation, particularly as it is likely to coincide with the end of QE2 [a $600-billion domestic economic stimulus measure] We estimate that the swing in Japanese purchases could be as large as 2 per cent of U.S. GDP," Mr. Marion said in a report.

Not all analysts are convinced that the yen's strength will last, however. John Higgins, a senior market economist with Capital Economics in London, predicted in a note to clients that the Bank of Japan will intervene "substantially" in currency markets to weaken the yen and offset the effect of repatriation of funds from overseas.

At $886-billion, Japan is the second-largest holder of U.S. Treasuries, behind China. U.S. stocks and bonds accounted for $384-billion worth of Japanese capital outflows between 2005 and January of 2011, according to Japan's Finance Ministry. Also vulnerable to a large-scale yen repatriation are countries in Western Europe, which accounted for $309-billion of Japanese capital outflows during the same period, and Australia, which accounted for $76-billion. Canadian stocks and bonds attracted less than $20-billion of Japanese capital between 2005 and 2011.

A stronger yen harms Japan's export sector, the world's fourth largest, by increasing costs and reducing competitiveness. Traders are betting that the Bank of Japan will intervene in currency markets by selling yen to weaken its value.

The yen has appreciated 3.5 per cent against the U.S. dollar since Thursday, when the quake and tsunami killed thousands and devastated towns and villages. Major manufacturers such as Toyota Corp. and Sony Corp. shuttered production at damaged factories. As the potential for a nuclear meltdown looms, a series of rolling blackouts and water shortages are further disrupting production and global supply chains.

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The yen had already been on a sharp upward trajectory before the disaster, appreciating 15 per cent in 2010. The Bank of Japan sold two trillion yen ($25-billion) in September in an attempt to weaken the currency, the central bank's first intervention since 2004.

Raising fears of major yen repatriations are estimates of quake- and tsunami-related losses faced by insurance and reinsurance firms of between $12-billion and $25-billion. However, Dow Jones Newswires, citing sources familiar with conclusions reached by Japanese financial authorities, reported Wednesday that yen repatriations have so far been "negligible" and "inconsistent with rumours of large-scale fund flows."

Mr. Higgins of Capital Economics said "there is little reason to suspect that Japanese investors will not want to continue to invest overseas in the medium term given the adverse impact of the disaster on Japan's already beleaguered economy and public finances, and the possibility of (somewhat) tighter monetary policy in other major economies."

Countries dependent on trade with Japan will be affected in the short term amid expected weak demand from Japanese consumers and corporations. The most vulnerable are nations where the Japanese market accounts for more than 10 per cent of exports, which include Indonesia, the Philippines, Thailand and Malaysia.

The Canadian dollar has weakened since the disaster, falling in tandem with oil prices and interest in commodity-driven, risk-related currencies.

However, many analysts expect commodity demand to rebound sharply once rebuilding efforts begin in earnest.

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"The correction lower in the crude price may not be lasting. Indeed, with Japan possibly moving away from nuclear-based energy production - and with tension in the Gulf still high - crude prices may achieve new highs in the coming months," emerging markets strategists at RBC Dominion Securities said in a report.

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About the Author
Asia-Pacific Reporter

An award-winning journalist, Andy Hoffman is the Asia-Pacific Reporter for Canada's national newspaper, The Globe and Mail. More

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