"The Secrets of Speaking Japanese"

What not many people realise is that there are a number of forms of Japanese - all of which are difficult to learn. Fortunately, there are texts like "13 Secrets of Learning Fluent Japanese" by Giles Murray with lessons like the one that teaches you 33 colloquial Japanese abbreviations using a mini-graphic novel about a weekend-in-the-life of the gloomy and alcoholic Tokyo salaryman Shigeo Tada. Then there is the more obscure and difficult version of the language: the language of Japanese economics or, more precisely, the language of the yen.

On a number of different counts, economic, mathematical or thematic there are good reasons why the yen should be holding its own, or in the case of the US dollar, appreciating against major currencies. Using our own modified purchasing power parity model, for instance, shows the theoretical nature of a gentle re-rating of the currency against the US dollar and, at the same time, how volatile reality is around this trend.

As at May 2006.

Although the latest bit of yen strength is but a blip over the long-term, it remains a worry that what should happen, if we apply our western Socratic thinking, isn't necessarily what will happen because we are not fully appreciating the subtleties of the language of Far Eastern economic management.

The first thing to appreciate is, and this is going to come as shock to free-market radicals who think that the global markets are a legitimate game to be played out by the precious and privileged few for their own personal gains, the Far East doesn't like currency volatility. In fact, it typically doesn't like volatility in any of its markets whether currencies, bonds or equities. They would philosophically and temperamentally like things to stay the same for very long periods of time. For instance, it was mooted a few years ago that there should be a Far Eastern version of the European Exchange Rate Mechanism. This sounds like a good idea but it was rejected on grounds that once you openly define rules of engagement it automatically opens you up to analysis and ultimately attack. This is why many of the rules of exchange rates (like the composition of currency baskets) are a secret. It's also why there is a lot of indirectness about Far Eastern currency analysis, which uses unconventional measures to gauge future movements.

The overriding idea to keep in mind is that "good fences make for good neighbours" and anything that stops them from looking over the fence is a good thing. You have to admit this has been a highly effective policy. Getting currencies like the yen right has confounded many a speculator and investor (like us) who time after time have divined the correct preconditions for a secular movement in the currency only to be batted back a few weeks later because it has gone in the opposite direction or it has just not worked out as expected in the timescales we deemed reasonable. Of course, the Japanese authorities have been complicit in this; they have thrown literally billions of dollars at the problem of warding off currency speculators in the past years but it just goes to show that only applying the simplistic rules of western analysis just isn't good enough for the yen.

One of the marginal indicators that we should be looking at with respect to the yen, and in the process maybe calm our nerves a bit about the recent few percent reversal, is things like the above; the rate at which the Bank of Japan is draining money out of the Japanese system to prepare it for an interest rate rise. After a brief pause, they appear to have resumed their activities, so a rate rise is definitely coming - we just don't know when. Hence, there is a massive element of timing in getting the yen portfolio policy right.

For those of you who, like us, are concerned about the idea that the Far East is turning from being the exporter of deflation to the exporter of inflation to the west, this should add to the possibility that the yen will resume its upwards movement in the coming months. In recent years the old idea that "currencies depreciate when inflation appears" has been replaced by the notion that "if you have inflation you have growth (which is good), a positive trade balance (which is good) and rising interest rates (which is also good) should make your currency appreciate" all of which apply to the yen. One of the indirect indicators, part of the secret language of Japanese economic and currency management, is the Bank of Japan current account as shown above which gives us some comfort in continuing to own the yen. But when it moves it may move in an unexpected way and at an unexpected time and for that reason alone we are using currency options to express some of yen policy at this time.