Last month Japan experienced a foreign trade deficit for the first time in decades (article here). Many factors are behind this. One such factor is the exchange rate. For a long time it was around 110 yen per US dollar, but over the last few years it’s plummed to less than 80 yen per dollar.
About a year ago I recall an article saying that the Japanese government was going to try to improve that exchange rate so as to help its export businesses.
So what can they do to deliberately influence that exchange rate?
They can also change the interest rate on government bonds and on money lent from their reserve bank. These rates affect the attractiveness of investing in their currency, and thus the value of the currency.
Eventually something is worth what someone else is prepared to pay for it. If they want to affect the value of their currency they need to affect its apparent value. Printing more money dilutes the currency’s apparent value, and changing interest rates affects the profit in investing in that currency, and hence its value.
To raise the value of their currency - buy their bonds off the world market. This is the same trick some companies do when they think their stock is undervalued… Buy it and it increases demand, raises the price. They also can raise interest rates, as others mentioned. Ultimately, a country’s bonds are worth what people think they will be worth. Higher interest rates sound good. This attracts foreign money which means the exchange value will also be high when the bond is redeemed and converted back to the original buyers country currency.
The first one, buying bonds on the open market - the government burns up its foreign reserves (cash of other countries currencies) buying on foreign markets, so this works best if the central bank has a surplus of foreign cash. Raising interest rates has its own dangers.
The governement says it’s going to buy the “other” currency at a higher price and nobody will sell you dollars at the lower rate.
The stronger version is price control of foreign currency.
The strongest one is a governemnt monopoly.
Most goverments do these types of things regularly to influence their own currency. That is why foreign currency is probably the most difficult financial instrument to attempt to forecast.
Are you certain you don’t have that backwards? My understanding is that buying bonds increases their price and therefore lowers their yield, making prevailing interest rates lower and the currency less attractive to interest-seeking investors. Selling bonds increases their supply, lowering their price and therefore increasing their yield, enticing holders of foreign currency to buy your currency to use to buy the bonds.
Or, from a money-supply perspective, buying bonds, at least for bonds denominated in your own currency, is done with “new” money, so the action increases the money supply. Selling bonds takes the money that is used to buy the bond out of the economy (promising to put it back later of course, but that’s later).
Buying bonds off the world market in a foreign currency (i.e. We’ll buy these Yen for $X dollars US.) sets a floor price and increases demand. The downside is that you need the dollars on hand to do this. The bank gets those dollars in one of two ways - either borrow them or buy them. The National Bank of Japan can’t create dollars.
Borrowing dollars means putting the future value of the Yen at risk - you take on not only the cost of the interest rate of the loan, but the risk that the Yen goes down and i costs much more in Yen to pay back a dollar.
Buying dollars means finding people that need Yen and have dollars. This ultimately comes from people wanting to buy what Japan owns or makes. (i.e. Land n Hokkaido, or Sony cameras).Usually this money, foreign reserves, is accumulated over years and spent in short term.
FOr instance, this spring (2012) Egypt is blowing all its foreign cash reserves to ensure the Egyptian pound does not drop too much from the nominal 6 per US dollar exchange rate. They don’t want a currency devaluation in the middle of the presidential election. To do this, it has bought Egyptian pounds people are trying to unload. Unfortunately, the only main thing Egypt sells is tourism and that foreign income is way down. Meanwhile, food imports, etc. still come in and have to be paid for.
Importers either buy in LE (Egypt Pounds) or go to the central bank and buy dollars/euros. If they can pay in LE, the person they buy from makes the conversion. Tourists pay for hotels in euros and dollars, which the hotel exchanges for LE at the bank to pay their workers, etc. In the long run, these balance or the value of the local currency goes down until they do.
theEgyptians are keeping things the same by burning up their savings.
The article indicates the Egyptians are trying to get a loan from the EU and IMF - just a cheap way to borrow so they can keep going. However, the last decade or two these loans come with conditions - what to change so the economy gets in balance without grinding to a complete halt.
If Japan wanted to effectively fix their exchange rate they could either impose strict capital controls (China) or simply give up their ability to independently make monetary policy decisions (EU member countries). In the absence of explicitly setting a rate, however, many of the monetary (and to a lesser extent, fiscal) policy recommendations listed above would do well to influence the exchange rate.
This is all backwards, when the currency goes up your goods are dearer for other countries to buy, you want the currency going down for exports to go up.