Falling Yen=Stronger Dollar

I could keep going on about Japan's news but I'm going to stop it with my analysis of the falling yen. While I am a student of economics and finance I haven't taken any classes that really covered currency markets. Therefore, while I don't know the ins and outs and the magical ways to get rich off this type of asset (yes currency is an asset) I do believe that, based on what I've read and what I know about finance in general, I can give a pretty decent analysis of why the yen is weaker than it was a few months ago.

If you've paid attention to this type of news like I have over the past month and a half, you would have noticed the dollar going up in value relative to the yen (and all other currencies). Last August the rate was around 115 yen to 1 USD and now according to the latest figures on yahoo finance, the rate is 119.06 yen to 1 USD. From the US's point of view the dollar is rising and from Japan's point of view the yen is falling. This is especially bad for me because I receive my money in terms of yen and when I go back to the states I'm going to suffer an economic loss due to currency risk.

Currency risk is the risk one undergoes when dealing with currencies from other countries. Because most currencies are floating currencies, their value relative to other currencies changes. To the currency trader, this risk is similar to any other traded asset like a stock- the price can rise or fall and lucky ones buy when it's low and sell when it's high. I face the same risk only it's slightly different.

Why should I care about the exchange rate since I don't see the prices of goods changing with the exchange rates? I really don't. I know I'm going to get about 130,000 yen a month and I can budget my expenses knowing confidently that the prices for food and my internet aren't going to fluctuate. However, I benefit from an appreciating dollar when I withdraw cash from my American bank account; Moreover, I benefit from a stronger yen when I go home and change my savings from yen to dollars. All in all, it's not that much money to me...but multiply what I deal with by 10 or 100 and it suddenly becomes looks like a lot more.

So why is the yen doing so badly against the dollar? Nobody knows the correct answer to this question. Like the stock market there are an infinite number of variables that change exchange rates. However, some of the major indicators are stock indices, economic data (GDP, unemployment, etc) and interest rates.

Looking at the S&P 500 index, which is probably the best overall indicator of business activity in the United States, you can see the average steadily rising over past three months. This means the aggregate level of stock prices have risen. Why do stock prices rise? because people are willing to throw down more cash for ownership in a company. Why are people willing to do this? Because the value of the companies are rising. Why are the values of the companies rising? Because the present value of future cash flows have risen. This means that forecasters (individual investors and analysts) see the companies as good investments which is a reflection of the investment choices a company takes-it chooses to take on investment opportunities(be it a new product line, bonds, mergers and acquisitions) that yield positive returns. That is how stock prices work in theory. Every bit of information affects the present value of a company's future cash flows and in result the company's stock prices are always changing.

The fact that businesses are becoming more valuable is a good economic indicator. It means that companies are investing their resources in new "positive NPV" projects. It is a good thing to buy stock in these American companies meaning it's a good thing to hold US dollars as the rate of return of investing these US dollars in US stocks is higher than investing them in other places. The American stock market is more attractive than the Nikkei right now-looking at the Nikkei 225 index over the past three months you see a line that has fallen and is rather flat. It makes sense for investors to invest their money in the United States over Japan because of this reason.

Economic data such as GDP, unemployment, inflation, etc. are also large players in the market for currencies as they are aggregate indicators of a country's growth. However, I'm not really going to go into these reasons because I don’t know much about them. haha.

Interest rates play another large role in determining exchange rates. When the FED raises the Fed Funds rate, banks subsequently raise the interest rates they charge to customers. The Fed changes rates as an effort to curb inflation and prevent recessions: rising rates in the prior condition and lowering rates in the latter. To fight against inflation the FED increases interest rates making it more expensive to take out loans making it harder for people to spend as much. Moreover, it becomes optimal to put money in these banks as the return on your money is higher.

Currently in the United States there is fear of inflation; consequently, the Fed has been raising interest rates. However, the equity markets aren't reflecting this. As I'm not a professional and I haven't been keeping up with the news, I'm not sure why this is-my only explanation would be that investors believe the interest rate increases aren't going to last.

This makes the dollar even stronger on the international scene-with higher interest rates and higher returns on its equity markets the dollar is looking pretty good. Investing in stocks will give you a higher return and the interest you earn on putting your money in the bank is also higher than it would be otherwise. This is especially apparent in Japan, where the government is trying to ward of deflation by keeping rates really low (less than 1%). This is why it's stupid to open a savings account in Japan right now-why put your money in an account yielding less than 1% when you can make around 4.5% in the United States?

Is the falling currency bad for Japan? Not necessarily, a too-strong yen was responsible for the bubble era that still has reaping effects on Japanese businesses. A weaker yen means that Japanese imports are cheaper to American businesses-the same yen price is paid in Japan; however the dollar prices that Americans are facing back home is less. It's really a win-win situation as more Japanese products are imported for a cheaper price in the states.

This also helps our trade deficit, as Japanese receive interest payments and coupon payments on US treasury Bonds (in dollars) they are more inclined to reinvest their cash in the American economy where they make higher returns. More foreign investment means more money for companies to employ Americans in expansionary efforts.

That’s my take on the news. It's a really long post and I apologize...I kind of got lost in the moment. peace. Glizz.