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On the yen/loonie exchange rate

Tue 15 Mar 2011 by mskala Tags used: ,

This chart, reproduced as fair dealing from Yahoo! Finance, shows the price of one Japanese yen in Canadian dollars for the last five days. See below for why I think this is an amazing chart.

Exchange rate chart

Currency markets are complicated, but I think they're best understood in simple terms of supply and demand. If you're doing well, making lots of goods that other people want, and you're not too dependent on others, then people want to buy your currency so they can buy your goods, and you don't have to sell too much of it to buy other people's goods, and so the price of your currency goes up. Strong country, strong currency. Conversely, if you're heavily dependent on the rest of the world, or if you're not making much that the rest of the world wants, then you need to sell lots of your currency to buy things from elsewhere, and other countries aren't so eager to buy it, and the price of your currency goes down. Weak country, weak currency.

The cause and effect works in the opposite direction too, though, because if your currency is weak, then your export goods become more appealing to other countries, so they buy your goods and your currency and that tends to make your economy stronger so that your currency will then rise. It's supposed to be self-balancing. And governments have some power to manipulate exchange rates, which they do in order to further their own goals, and that's how (for instance) the USA and China got into their current game of "chicken" where each side is trying to lower its currency faster than the other, and both sides are going bankrupt in an abusive codependent spiral.

Now look at the chart again. Japan just had the biggest earthquake in its history - bearing in mind that that's the biggest earthquake in the history of a highly earthquake-prone region - followed by a correspondingly big tsunami, and is currently in the throes of a nuclear crisis. And its currency is going up.

But is the yen really going up, or is the loonie just going down? Some of both. Here is a partial screenshot from the front page of Kitco, showing current spot rates between the US dollar and a bunch of other currencies.

[Exchange rate screen shot]

(Note: there is something weird about that image causing it to show up as a blank space in my own browser, even though third-party screen shots display it correctly. This may be a bug in my browser. If you can't see the screenshot, try clicking in the blank space.)

Look at all that red. Compared to the US dollar, everything on the list is down except the yen and the Swiss franc, and of those the yen is further up. Using the US dollar as the basis for comparison may be questionable given that it's the scrip of a bankrupt regime, but if you look a little closer, at the actual percentages instead of what's up and down, you can get a better idea of what's going on. Resource-heavy economies, like Canada, Australia, and South Africa, have been hit hardest. Canada's been doing pretty well recently (we're over par with the US dollar again), largely because we have oil, but the events of the last few days have acted against that trend. Why?

The story being told in the news (this item by Jessica Mortimer from Reuters is my favourite) is that because of the disaster in Japan, investors are pulling out of currencies perceived as risky - such as those of oil-producing countries, including Canada. With everything going to Hell, fewer people will be buying oil, so being a country that has oil is less valuable than it used to be. Meanwhile, investors seek "perceived safe haven currencies" (the Reuters reporter's phrase), including the Japanese yen. Also, insurers of Japanese assets are going to have to make large payouts to their policyholders, and they need to buy yen to do it.

So, quiz time. Which disaster is worse?

  • A. A magnitude 8.9 fucking earthquake, followed by a correspondingly large tsunami, massive loss of life and property, and a nuclear crisis.
  • B. People might buy less oil.

According to the chart at the top of this posting, investors believe that disaster B is worse, and that the safe thing to do in such a case is to move money into a more stable place, like the place currently experiencing disaster A.

It is not my position that these investors are necessarily wrong. I don't know the foreign exchange racket well enough to know what's a smart move. That's why I don't bet my money in that market. They may well be right to shift their money around in the way they are apparently doing. There are a number of complicating factors, including the history of the "yen carry trade" (under which a lot of people borrowed a lot of money from the Japanese in the recent past), and this insurance thing, and so on. It could be said that Japan is Bizarro World, everything is backwards there, and that's just the way it is. My position, though, is that if these investors are right and it makes sense for the yen to go up, then we're all in serious trouble, because we've gotten way too dependent on the wrong things, to the point that "people might buy less oil" hits an economy harder than "magnitude 8.9 earthquake etc."

On an optimistic note, at least this bodes well for Japan recovering from its troubles - if lots of people with lots of money are willing to bet on that happening, it can be self-fulfilling.

I also note that the Nikkei index (that's the main Japanese stock index) dropped 10.55% yesterday. That's pretty understandable: disasters cause stocks to plunge. Compare that with the "Black Monday" selloff of October 19, 1987, in which the US Dow Jones index dropped 22.61%. There's another disaster comparison for you: a magnitude 8.9 earthquake and so on is bad enough to cause the index to drop 10.55%. "Nobody's entirely sure why but it seems to come down to lots of people being really stupid and leaving everything up to the computers" - that was bad enough to make the index drop 22.61%. Again, it appears that financial markets are heavily dependent on stupid things.


Lisa Simpson: “Look on the bright side, Dad. Did you know that the Chinese use the same word for ‘crisis’ as they do for ‘opportunity?’”

Homer Simpson: “Yes. ‘Crisitunity!’”

Disaster leads to rebuilding, jobs, economy in high gear (think decades after WWII). As far as markets are concerned, disasters are not actually a bad thing. Bo - 2011-03-15 18:10
Look at the exchage rate again.

I think the explanations you were given were deliberately misleading. def0 - 2011-03-21 11:15
Eric H.
Nonsense, Bo. Look up broken window fallacy. Eric H. - 2011-06-12 07:00

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