Maybe someone can help me understand the following:
“Speculators are becoming increasingly confident about pushing the [dollar/yen] currency pair around,” said Michael Woolfolk, senior currency strategist in New York at Bank of New York Mellon Corp., the world’s largest custodial bank, with more than $20 trillion in assets under administration. “Everyone is curious to find out why they chose not to defend the 80 level. Wow. That’s all I have to say, just wow.”
The yen gained to 77.48 per dollar at 5:42 p.m. in New York after passing its post-World War II high of 79.75 reached in April 1995, from 80.72 yesterday.
“We’ve breached 79.75 and there was enormous support there initially and that’s given way with stop losses on a New York close in extremely thin conditions with absolutely no signs of the Bank of Japan and the selling has just snow-balled,” said Kurt Magnus, executive director of currency sales at Nomura Holdings Inc. in Sydney.
For those who don’t follow the yen closely, 77 is an insanely high level. Japan’s currency is showing amazing strength, and the BOJ is nowhere to be seen. Tight money in an economy that shows no signs of overheating—unless you count nuclear power plants. I don’t get it, but then I’ve never understood anything the BOJ did or did not do.
It pains me to write this post, as I am a big fan of Japanese culture. Although I have never been there, I love the country. But the truth is that Japan is not particularly good at handling disasters (as we found out after Kobe), and of course has a very spotty record on nuclear safety. On the other hand there may be a tendency for people to get overly emotional about nuclear issues, so I really don’t know whether markets are over- or under-reacting. (Yes, I’m a typical two-handed economist. Pay no attention to my forecasts.)
I almost threw a shoe at the TV when I heard a newsman say the nuclear power plants were built to withstand earthquakes, but that “no one could have predicted anything this severe.” Really? I think Chileans, Russians, Indonesians and Alaskans would have had no trouble predicting 9.0 or higher earthquakes–which are not particularly rare, at least not for a power plant built to last for many decades and located in one of the hottest parts of the “ring of fire.” These “black swans” (which might as well be named the official bird of the 21st century) are coming more and more frequently. The reaction of authorities makes me more likely to believe those people who warn about the possible effect of solar flares knocking out our electrical grid, or genetically-engineered flu viruses causing pandemics.
[BTW, I think my post “Stuff Happens” holds up pretty well.]
In some ways recent events remind me of the Great Depression:
1. The central banks didn’t provide enough stimulus. Some actions were taken, but they would only be effective if things went smoothly–no bumps in the road to recovery.
2. There were lots of bumps. More importantly, there were lots of shocks that wouldn’t have caused much of a problem had we not been in a depression. Smoot-Hawley. The November 1930 bank run. Credit Anstalt. France delaying Hoover’s attempt to rescue Germany. Britain leaving gold. The election of 1932. War scares in the late 1930s. Often these shocks had effects that seemed quite different from what one might expect, for instance Smoot-Hawley was very deflationary in May/June 1930, despite the fact that economic theory says tariffs are inflationary. (And remember how the Libyan uprising seemed to reduce nominal interest rates?)
I’ve indicated many times that adverse supply shocks can reduce NGDP, if they become entangled with monetary policy. And that’s especially likely to happen in a depression, when traditional monetary tools are ineffective. Of course just as with fiscal stimulus, the Fed can neutralize the effect on NGDP. So why doesn’t that appear to be happening? Partly it’s because the Fed is targeting inflation, not NGDP. Fiscal austerity reduces inflation, something the Fed might well offset. An adverse oil shock (or disruption of the production chain in Asia?) raises prices, and hence is less likely to be offset with monetary stimulus. We saw the Fed fail to react to a drop in AD during late 2008, partly due to an unhealthy focus on headline inflation (which had soared with oil prices.) Could the same thing be happening again?
I suppose some people will roll their eyes and say “Sumner thinks even nuclear meltdowns can be fixed with monetary stimulus.” Actually, I don’t think we should react to nuclear meltdowns or any other situation by changing our monetary policy target. I favor stable NGDP growth. The problem isn’t that money is not becoming more expansionary, the problem is that monetary policy (in the US and Japan) is becoming more contractionary. I’d be happy if they simply stayed put.
The article quoted above did find a few countries that still “do monetary policy” Countries that actually have targets, that aren’t passive in the face of shocks:
The Australian dollar fell to as low as 97.35 U.S. cents, the least since Dec. 2, before trading at 97.89 cents as of 8:32 a.m. in Sydney. The kiwi dollar slid to 71.30 U.S. cents, the lowest since Sept. 2.
The Aussie tumbled 3.5 percent to 75.56 yen, while the New Zealand currency dropped 4.5 percent to 55.39 yen.
Sweden’s krona dropped against most major currencies, falling 1.3 percent to 6.4826 per dollar and 2.7 percent to 12.28 yen.
Rather than say Sweden and Australia’s currencies are falling, it might be more accurate to say the yen and the dollar are rising.
Some people have argued that this event might actually help the Japanese economy. I doubt it. Of course there’s the broken windows fallacy, but the more sophisticated arguments are that Japan will react with major fiscal stimulus, and that this will somehow force Japan out of its liquidity trap. I find that implausible, and I’m pretty sure that Japanese stock investors agree with me. Still, it is certainly possible, especially given the size of Japan’s national debt. I hope I’m wrong.
PS. Will Wilkinson has a good post on the economic effects of disasters. But keep in mind my cautionary note on the Great Depression. The effect of shocks is very much context-specific.
PPS. I know that the 77 level was something of a blip–the real question is why the yen isn’t going much lower.