Japan’s currency, the yen, is known to be the third most commonly used currency in the planet, just behind the euro and the United States dollar. It has been seen as the proxy for Asia for decades. While the importance of China’s currency has rapidly increased in the recent years, due to its lack of flexibility and managed status has Japanese yen still is the preferable Asian reserve currency. Kavan Choksi underlines that it also is the fourth most popular reserve currency after the United States dollar, euro and sterling.
Kavan Choksi highlights the low interest rate regime of Japanese yen
When there is political or economic uncertainty in Asia, a lot of investors tend to express their views through the Japanese Yen. Hence, in case breaking news causes a crisis of confidence in Asia, there are likely to be big moves in Japan’s currency, even if the problems are not in Japan. However, this is not the most interesting aspect of the Japanese yen. The biggest highlight of this currency is that the Japanese Yen happens to be its long history of zero rates. Japan, in fact, pioneered the idea of zero rates more than two decades back. Today a handful of nations have interest rates that are below, near, or at zero.
The low interest rate regime of Japan definitely has its critics. A lot of people argue that this has done not much to stimulate the economy. But zero interest rates are actually spreading in many parts of the world and there are many lessons one may learn from Japan’s experience. Zero interest rates basically force individual and individual investors to search for yield abroad. The zero rate policy in Japan has driven trillions of dollars out of Japan. For almost three decades Japan has been the biggest investor in the world. A lot of this money has gone to bonds, real estate and stocks from emerging market countries. As other nations across the world lower their interest rates, they may also experience a massive investment inflow.
Zero rates in Japan have also made the Japanese Yen one of the most popular funding currencies. The extremely low cost of borrowing involved in this currency makes it quite an attractive vehicle for funding purchases of currencies, and subsequently turn investments with greater interest rates and yields. It was such a popular funding currency that many argued it played a major role in the 2007-2008 Great Recession. Prior to the financial crisis, there used to be a strong appetite for risk. Hence, a lot of money provided by selling yen flowed into risky assets like collateralized debt obligations, and residential subprime mortgage backed securities. As the bubble burst, these assets crashed in value, and yen funded trades were quickly unwound, thereby reducing liquidity in U.S. dollars and other currencies. Central banks around the globe eventually responded with Quantitative Easing, which involved pouring new money into the economy. In the opinion of Kavan Choksi, looking forward as other nations drop their interest rates to zero, investments that are funded with low yield currencies might witness a revival.