Japan's natural disasters bring about mixed consequences. The major talk now is the Yen's rally against the dollar. Many were confused about why a currency will appreciate during such a grave disaster. The opposite being reminiscent of the New Zealand earthquake a few weeks ago. It's usual to draw this nieve comparison without a closer look into the specific fundamentals behind the Japanese economy. Government and businesses in Japan have huge savings in US Dollars, which they have to sell in order to buy Japanese Yen to spend on reconstruction. The spending will directly target sectors that require a lot of labor - construction and cleanup. The economic indicators following this disaster will be important. Employment, capital flows, and productivity are the main factors that will formulate Japan's recovery. Despite Moody's tough stance on Japan just before the earthquake; stating that the country is at a fiscal 'tipping point', its savings will give it a boost. Japan is a wealthy nation in terms of its portfolio of savings, in which its opening gave birth to a now powerful Yen to aid in recovery.
A negative consequence of a rising Yen is obvious. Exports define Japan's economy, and with its goods being expensive in international trade, there is little hope for constant demand. Japan's exports are now on a tightrope. Will partners purchase at a higher Yen and be willing to factor in the opportunity cost for higher quality goods? Technology from Japan is innovative and gives it advantage along the supply chain. Japanese automakers like Toyota will experience a decline in sales as their vehicles become more expensive for countries like the US to import. This gives US automakers like GM and Ford a slight advantage. However, key parts from Japan are delayed in shipment to major plants such as GM's Louisiana pick up truck production center. A major bottleneck in the supply chain could cripple industries that rely on Japanese parts.
The initial sell off of US Dollars in exchange for Yen was acceptable. However, a continued rally will hurt the Japanese economy. To solve this problem, the Bank of Japan intervened earlier today to sell massive amounts of Yen. This devalues the currency and makes more Yen available. The circulation of Yen will do well for reconstruction spending now that the savers have converted currency for their own recovery plans. The G-7 pledged to intervene to sell more Yen.
Japan is a unique economy, which is why the well calculated monetary actions must be followed by similar fiscal responsibilities. I don't see massive amounts of debt needed, being that the domestic capital flows seem sufficient enough in allocating monetary resources to aid in redevelopment. The Japanese government, if it continues a responsible path, will hopefully get off that tipping point and prove a lot of pundits wrong. The lesson of smart leadership brought about through crisis.
There is one major concern lurking behind the optimism. The radiation levels from nuclear plants damaged during the earthquake are dangerous. The government and scientists behind the plant are criticized by the international community (especially the US) about its cover up. Many believe that the radiation levels are far worse than reported by the Japanese government. Parts of Tokyo have been evacuated due to uncertainty. This problems needs to be a top priority, because the long term effects on the people of Japan will not be pretty.
The Yen's volatility is uncomfortable for trade entry. However, I do see a trend reversal as the G-7 prepares its intervention. There is risk that speculation will continue to push the Yen higher despite these sudden spikes of devaluation. At this point, there is more information about the monetary game plan to provide some short term trading strategy. The large US Dollar purchases will probably do well in other dollar base pairs. Follow my live trades here.
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