Example research essay topic: Foreign Exchange Oxford Blackwell - 2,670 words

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The paper discusses the history of yen and its influence on the global economy. It identifies and explains the changes of yen relative to dollar from 1970 s to present. The paper discovers reasons that influenced yen / dollar exchange rates over the years. Outline Introduction Discussion History of yen Rise of yen as a major currency Yen/Dollar exchange rates Role of yen in the global economy Conclusion Changes in the Value of the Dollar relative to the Yen from 1970 to Present In 1960, the Japanese government introduced a Foreign Trade and Foreign Exchange Liberalization Plan, but due to several reasons market volume remained low. On the one hand, trade-related international transactions were often carried out overseas or kept internal to the large Japanese trading companies.

On the other hand, portfolio capital flows were small. There were strong controls of capital exports as well as of capital imports. For example, although the first bond issues by Japanese corporations abroad took place as early as 1961, up to the beginning of the 1970 s the Euromarkets accounted for no more than 1. 7 per cent of Japanese corporate financing. Non-resident activities in the Japanese capital market were even more modest. When samurai bonds, yen-denominated bonds issued in Japan by non-residents, first appeared in the 1970 s, the market was only open to foreign governments, government agencies and international organizations. It was only in the early 1980 s that it was opened to foreign corporations and other non-governmental institutions with a single-A rating, and since August 1992 to foreign government-affiliated bodies with a BB+or BBB rating.

Shogun bonds, foreign-currency denominated bonds issued by non-residents in Japan, date from 1972, and non-resident Eurobonds issued in Japan and sold to investors in the Euromarkets even from 1977. At times, there were sporadic approaches to liberalization. For example, in 1966 trading companies were allowed to hold foreign currency and non-residents could open yen-denominated bank accounts in Japan. From 1970 on manufacturers could directly engage in foreign trade. But it was not until the end of 1978 that any individual in Japan could freely hold foreign currency or establish a dollar account with a Japanese bank.

The system of controls and regulations worked well until the early 1970 s. Then pressures for change became overwhelming. The pressures came mainly from two sources, an international and a domestic one. On the domestic side structural shifts in the economy brought a fundamental change in saving / investment relations among sectors. The corporate sectors need for borrowing sank while, at the same time, the government deficit rose leading to a huge increase in government bonds that fostered the development of the securities markets. Internationally, since the 1970 s, Japan had become a capital exporter due to a growing current-account surplus.

First, the authorities reacted by increasing their foreign exchange reserves allowing an over expansionary monetary policy. But, in the long run that strategy became untenable. With the currency turbulence's at the beginning of the 1970 s, and the experiences after the transition to worldwide floating in March 1973, it soon became clear that maintaining restrictions on private capital outflows would only increase the pressure on the yen exchange rate. There were two broad strands of reform, first a revision of the legislative framework controlling foreign exchange transactions and second, the internationalization of the yen by liberalizing euro yen transactions and creating a Japanese offshore market. The euro yen liberalization started in 1977 with the admission of euro yen bonds issued by non-residents. However, during the first years, only a few institutions were eligible issuers. 35 The markets flourished from 1985 onwards when the range of issuers was expanded and guidelines for the criteria they had to meet were modified.

Euro yen instruments are yen-denominated financial assets that are traded outside Japan. The main driving force behind the internationalization of Japans financial markets was the Yen/Dollar Committee, a US/Japanese group established in November 1993 when US President Reagan visited Japan. The committee met six times between February and May 1984 and presented a report suggesting major steps towards financial deregulation. The United States had been worried by the persistent trade imbalances between the two countries. With the Yen/Dollar Agreement they hoped for a reversion of capital flows putting the yen under pressure thereby reducing Japans current-account surplus. The Japanese side agreed in principle to a relaxation of controls despite considerable official fears of possible destabilizing effects on the financial system.

At the same time as Japan opened its system to the world, Japanese banks increased their international activities. In the early 1970 s yen had played only a minor role worldwide. Japanese banks had been mostly following their customers trade. In addition, as long as Japan ran a current-account deficit, international lending by Japanese banks was severely restricted.

In the 1970 s the banks international business expanded with one strong motive being the circumvention of official regulation in the domestic markets. The 1980 s then were characterized by Japanese enterprises in search of investment opportunities for their growing capital surpluses with Japanese banks providing the respective facilities worldwide. Arbitrage between the Japanese and international markets were greatly facilitated after the regulation of yen conversion in Japan was abolished in June 1984. The ending of the formal limits to yen conversion strongly contributed to the importance of yen as a foreign exchange currency. Another stimulus was allowing direct dealing between banks without the intermediation of a foreign exchange broker -- which was put into effect in two steps. It started in June 1984 with yen / dollar transactions remaining exempt until February 1985 (Hall, 1993).

The results of these developments were truly remarkable. For example, at the end of May 1984, the outstanding balance of yen swaps was? 250 billion. Two months later, at the end of July 1984, it amounted to more than? 1 trillion. By the end of March 1986 it had reached more than? 2. 5 trillion (Viner, 1988). In the second half of the 1980 s Japanese financial markets experienced dramatic changes. Stock and land prices boomed triggering a speculative bubble that seized the whole economy.

In December 1989, at the height of the bubble, the Japanese stock market made up 42 per cent of the total capitalization of world stock markets. In 1990, Japans total property had an estimated value of? 2, 000 trillion, that was more than five times the size of the countrys GNP and about four times the value of total property in the United States. The growth of the foreign exchange market, in a sense, reflected the overall development. In April 1989, the Japanese market had become the third largest worldwide with an estimated average daily foreign exchange turnover in Tokyo of about $ 145 billion. (See Appendix) More than a few observers regarded international developments at least partly responsible for the folly.

It all began in September 1985 with the remarkable success of the so-called Plaza Accord, an international agreement of the seven biggest industrial countries (G 7) to bring down the value of the dollar by joint efforts consisting of a mixture of combined interventions in the foreign exchange markets and announced monetary and fiscal policy measures. When, after a while, the subsequent fall of the dollar began to appear worrying as well, and, in particular, put pressure on US-Japanese trade relations, this success was to be repeated under reverse signs. In February 1987, another agreement was reached, this time to halt the dollars decline. At that time, with the Japanese economy in recession, the Bank of Japan was only too willing to bow to international pressure. Interest rates had already begun to come down earlier: between January 1986 and February 1987 the official discount rate in Japan declined from 5 to 2. 5 per cent. The loose monetary policy created a most favorable environment of cheap credit fuelling a speculative demand for all kinds of assets, from shares over property to art objects and golf club memberships.

Shares and property at inflated prices in turn widely served as collateral for new bank credit creating ever more waves of speculative demand. These developments were reflected in the balance of payments as well. During those years, Japans net long-term capital exports by far exceeded the countrys current account surplus as the demand for foreign assets financed by cheap domestic credit swelled. The long-observed relationship between trade and foreign investment simply broke down. Economists seriously question the validity of the traditional argument that a cheap dollar can improve the US trade balance when the world economy is integrated.

An exchange rate depreciation may have a favorable effect on the home countrys competitiveness, which was the case for Japan in 1980 s, but-if the economy is highly open-it also stimulates investment in the tradable sector and other components of absorption which has an adverse effect on the trade balance, with an uncertain net impact. For example, the coordinated policy to drive up the yen against the dollar caused a recession in the tradable sector of Japan in 1987 - 8 and depressed Japanese import demand so that the trade imbalance remained substantial despite a large change in the real yen-dollar exchange rate. The importance of exchange rate stability has resulted in a series of initiatives aiming to increase monetary and foreign exchange cooperation in the East Asian region. These initiatives constitute a first step towards a new approach to international monetary relations within the Asian region, a prerequisite for a larger use of the yen. In the 1980 s, Japan enjoyed a large current account surplus, due to three favorable external factors: low oil prices, low world interest rates and depreciation against the US dollar. In face of this new development, the government did not know what to do at first.

The possibility of allowing the Japanese yen to appreciate in order to maintain price competitiveness and reduce the external surplus never came to the mind of the countrys policy makers. Since the yen was depreciating in effective real terms, Japan at one point was accused of manipulating exchange rates. However, the large current account surplus did not benefit the national economy, either. The sudden increase in the money supply caused by the current account surplus resulted in speculative bubbles, over consumption and a subsequent balance of payment deficit. Therefore, the government decided to make major reforms in its exchange rate policies. (See Appendix) Why did East Asian policymakers maintain quasi- or de facto dollar pegs? One factor was the competitive advantage conferred to these currencies when the dollar was relatively weak in foreign currency markets from the mid- 1980 s.

However, the sharp appreciation of the dollar against the yen after April 1995 led to appreciations in the effective exchange rates of countries that were de facto pegged to the dollar, upsetting the relative competitive positions of these countries and contributing to the crisis that followed. In fact, barring the extreme of dollar ization, just about every arrangement is being used somewhere at the present time. This is not surprising in view of differences in the composition of trade, in the diversification of trade, and in the extent of macroeconomic stability. Because key currencies in the world move relative to each other the yen/US dollar rate-there are trade-offs between various considerations and, as a result, in different countries there are different optimum currency arrangements. The fluctuations of other currencies vis-a-vis the US dollar in the international foreign exchange markets also posed a problem, for they could not be properly incorporated into the yen-dollar exchange rate. Fluctuations in the value of the US dollar against other currencies in the international markets translated into corresponding changes in the value of the yen against those same currencies.

In other words, the Japanese economy was at risk of excessive dependence on the US economy. The yen, for example, tended to be overvalued relative to non-dollar currencies as the US dollar appreciated in the international market after the second oil shock. From January 1979 to February 1980, the US dollar appreciated by 19 per cent against the Japanese yen. Furthermore, as countries of Europe and East Asia became more interdependent in their trade and cross-border financial transactions, the relative importance of the exchange rate against those countries currencies increased in equal measure. The growing share of the European Union in Japanese external trade could also be reflected in a growing European share in official reserves. In addition, holding yen as a significant part of official reserves could be used in favor of holding Euros as well.

The inclusion of Euros in a countrys official reserves would give protection against dollar weakness and exchange rate risk in general. The Asian countries might gain from portfolio diversification as well. The sharp rise of the Japanese yen in early 1990 s significantly increased the debt service burden of some emerging Asian countries. If their debt portfolio had been more diversified, this would not have happened to such an extent. The introduction of the Euro in 1999 could provide the opportunity for such a diversification. Following the major depreciation's between the onset of the crisis, in mid- 1997, and the middle of 1998, currency values in East Asia rebounded somewhat and stabilized against the dollar for various periods under the flexible exchange rate arrangements that replaced the implicit pegs.

In the first half of 2000, many currencies in the South Asian, have depreciated, while only few have appreciated. Limiting his analysis to periods when the Japanese currency fluctuated sharply against the US dollar, Takagi attaches higher weights to the yen. (McKenzie, 1993) According to his findings for Indonesia, the Philippines, and Thailand, he emphasizes the tendency for the Korean won and the Malaysian ringgit to follow a depreciating yen (suggesting that these countries regard Japan as a close competitor in international markets), and for the Singapore dollar to follow closely an appreciating yen (as the authorities ward off imported inflation). These asymmetric responses, reflecting different national priorities attached to export competitiveness and price stability, would clearly complicate efforts to design a collective currency peg leaded by Japanese yen. The relative importance of the dollar and the yen in Asian currency pegs can be compared to nominal exchange rates against the dollar with other Asian currencies volatility against the yen.

Volatility against the dollar is uniformly lower than volatility against the yen, but the relative importance of the yen in Asian currency pegs. Bibliography: Hall, M. J. B. (1992) Implementation of the BIS Rules on Capital Adequacy Assessment: A Comparative Study of the Approaches Adopted in the UK, the USA and Japan. Lothian, J. R. (1991) A History of Yen Exchange Rates in Ziemba, W.

T. et al. (eds) Japanese Financial Market Research, Amsterdam: North Holland. McKenzie, C. (1993) The Money Markets in Japan in Takagi, S. (ed. ) Japanese Capital Markets, Oxford: Blackwell. Tateno, F. (1993) The Foreign Exchange Market in Japan in Takagi, S. (ed. ) Japanese Capital Markets, Oxford: Blackwell. Tables, G. S.

and Ozeki, Y. (1992) The Internationalization of Currencies: An Appraisal of the Japanese Yen, IMF Occasional Paper No. 90, Washington, DC: International Monetary Fund. Viner, A. (1988) Inside Japans Financial Markets, London: The Economist Publications. Appendix: Trading volume in the Tokyo foreign exchange market: Year Spot Forward Swap Total 1960 0. 3 0. 3 0 0. 6 1965 2. 1 1. 7 0. 8 4. 6 1970 4. 8 4. 2 2. 5 11. 5 1975 22. 9 26 24. 5 73. 4 1980 211. 8 66. 8 300. 6 579. 2 1985 462. 7 4. 4 968. 5 1435. 6 1990 2495. 7? b 3466. 9 5962. 5 a In billions of US dollars, b From February 1985 onwards forward transactions are included in swaps. Source: Tateno (1993: Table 14. 1) The yen / dollar exchange rate 1985 - 95:

Research essay sample on Foreign Exchange Oxford Blackwell