The yen and trade

The original theory advanced on behalf of floating exchange rates held they would produce self correcting trade balances (see “The dollar index and ‘firm’ exchange rates,” Currency Trader, December 2005). A trade-deficit nation’s currency would depreciate and have less power to purchase goods and services in the world market, while a trade-surplus nation’s currency would appreciate with the opposite effect. While this is true for the U.S. dollar (USD) and nearly every other currency of significance, the U.S. trade deficit has been uncorrelated with the DXY for more than 30 years.

However, Japan’s merchandise trade surplus does appear to be related to the JPY. If we map a 12-month rolling average of the Japanese trade surplus against a 12- month rolling average of the JPY, we find a stronger yen appears to lead a reduced trade surplus by about 18 months; the opposite is true for a weaker yen. The abrupt strengthening of the yen in the mid-90s reduced the monthly trade surplus on the order of ¥650 billion from peak to trough. A second way of looking at the same phenomenon is to map Japan’s exports as a percentage of its gross domestic product (GDP) against the JPY. The two series align closely between 1985 and 2001, and then diverge sharply afterwards. Before the Bank of Japan began (in March 2001) its program of “quantitative easing,” a technical term for shoving money down commercial banks’ throats, a stronger JPY reduced exports as a percentage of GDP. After quantitative easing began, the export percentage rose without the JPY weakening at all.