Yesterday's currency market intervention strengthened the yen and should finally silence skeptics who question whether governments can win a shoot out with currency speculators. The U.S. Treasury and the Bank of Japan won this skirmish. But it's not clear they can win the war.
The tide of battle was turned with a relatively small bank roll— no more than four billion dollars. Tokyo had tried to rescue the yen in April and failed, despite spending twenty billion dollars, which only shows that timing is everything.
This time intervention was successful because the markets were psychologically ready to turn and speculators were not willing to bet against the deep pockets of the U.S. Treasury. However, this success only confirms what we already knew— intervention works when governments sail with the wind.
But the wind will undoubtedly change. And whether we can ride out the next storm, depends on two issues:
Can China hold the line on its currency, the renminbi?
Can Japan finally carry through on its promises of economic reform?
The answer to both these questions is no.
Yesterday, China forced Washington's hand on intervention. The weak yen was pushing China ever closer to a devaluation and Beijing wasn't sure it could hold on much longer. Moreover, the White House couldn't tolerate the embarrassment of a region-destabilizing devaluation during President Clinton's upcoming visit to China.
But the underlying reasons for China to devaluate— the need to remain competitive and attract new foreign investment as it restructures its economy— will not go away. With growth slowing and unemployment rising, Beijing cannot hold its currency above the fray forever. If the renminbi goes, expect new pressures on the yen.
In Japan, in return for intervention, Tokyo has promised to speed the restructuring of its bank debt, to open its financial system and markets to foreign involvement, and to cut taxes. But the Japanese Parliament can't possibly do a new bank bailout before September and any significant tax cuts might force Prime Minister Hashimoto to resign in disgrace for bowing to foreign pressures. None of Hashimoto's likely successors will be better at reform, meaning the yen will likely weaken again.
So batten down the hatches. This intervention has only bought time and the real shootout in the exchange markets is yet to come.