Japan’s first yen-selling intervention in six years has lifted the dollar well above a 15-year low hit this week, raising questions about what authorities would consider success in the unilateral action. Just minutes after the dollar hit a low of 82.87 yen on Wednesday, Japanese authorities stepped into the market and made their biggest one-day intervention on record, selling an estimated 2 trillion yen ($23 billion). This is why GOLD keeps heading higher and as long currency (FX) intervention continues around the globe, Gold will head higher to new highs made today 1280. My target was 1300.

WHAT RESULT WOULD JAPAN CONSIDER A SUCCESS?

The chief aims at this stage appear twofold: dissuading speculators from aggressively selling the dollar against the yen by creating more two-way risk, and absorbing dollar selling by Japanese exporters repatriating earnings. The Ministry of Finance does not appear to be trying to drive dollar/yen to specific levels, having stepped back from the market since Wednesday’s spree of yen selling. Traders report that hedge funds have been getting out of long yen positions but may still have more to do. They also do not rule out chances of the Bank of Japan, which acts for the MOF, trying to push the dollar above 86.00 yen to trigger stop-loss buy orders and shunt it a bit higher. Japanese exporters are said to have held off some of their dollar sales in the hope of getting a better rate before closing their books on the fiscal half-year ending on September 30. Japan’s action is widely seen as creating an opportunity for them to sell before that date. Because of this, some think intervention may be scaled back or even put on hold after the end of September. Others are not so sure, believing that the MOF would not want to risk a sudden dollar slide by abruptly ending intervention.

WHAT KIND OF TACTICS ARE THEY LIKELY TO EMPLOY?

After the shock and awe of the first day, further intervention is likely to be more tactical and opportunistic. If the dollar stabilizes above 85 yen there may be no need to act. But if it starts to fall again on selling by hedge funds and other speculators, the authorities may show themselves somewhere between 83.00-85.00 yen. Traders say the uncertainty that has been created could last for a week or two, but if there is no follow-up action and the dollar remains under broad pressure — for instance, from expectations of more Federal Reserve quantitative easing — selling pressure will build again. Intervention also tends to suppress volatility, allowing big positions to build up that may result in bigger price swings when authorities back away.

HOW MUCH CAN THEY DO?

Japan raised its borrowing limit for forex intervention in the budget for fiscal 2010/11 by 5 trillion yen to 145 trillion. Before the first round of yen selling on September 15 the funds available were roughly 35 trillion yen ($408 billion). Analysts say the authorities cannot intervene for long as heavily as they did the first time, but there is plenty of money for a few more rounds of large-scale intervention.

DOES THIS SIGNAL A MORE PROACTIVE STANCE TO FIGHT DEFLATION?

With the government having played its part in curbing yen gains with intervention, it may pile pressure on the BOJ to take further action to beat deflation.

The BOJ is well aware and may ease monetary policy at its next rate review in early October. An increase in outright government bond purchases has been floated as among the more likely options, sources say.

The central bank has been hesitant of increasing bond buying from the current 21.6 trillion yen per year, fearing that it would be seen as printing money to finance public debt. But it may not have much choice if the effect of intervention begins to fade, heightening pressure on the BOJ for more action.

History

Official international reserves, the means of official international payments, formerly consisted only of gold, and occasionally silver. But under the Bretton Woods system, the US dollar functioned as a reserve currency, so it too became part of a nation’s official international reserve assets. From 1944-1968, the US dollar was convertible into gold through the Federal Reserve System, but after 1968 only central banks could convert dollars into gold from official gold reserves, and after 1973 no individual or institution could convert US dollars into gold from official gold reserves. Since 1973, no major currencies have been convertible into gold from official gold reserves. Individuals and institutions must now buy gold in private markets, just like other commodities. Even though US dollars and other currencies are no longer convertible into gold from official gold reserves, they still can function as official international reserves.

Purpose

In a flexible exchange rate system, official international reserve assets allow a central bank to purchase the domestic currency, which is considered a liability for the central bank (since it prints the money or fiat currency as IOUs). This action can stabilize the value of the domestic currency. Central banks throughout the world have sometimes cooperated in buying and selling official international reserves to attempt to influence exchange rates.

Costs, benefits, and criticisms

Large reserves of foreign currency allow a government to manipulate exchange rates – usually to stabilize the foreign exchange rates to provide a more favorable economic environment. In theory the manipulation of foreign currency exchange rates can provide the stability that a gold standard provides, but in practice this has not been the case. Also, the greater a country’s foreign reserves, the better position it is in to defend itself from speculative attacks on the domestic currency.

There are costs in maintaining large currency reserves. Fluctuations in exchange markets result in gains and losses in the purchasing power of reserves. Even in the absence of a currency crisis, fluctuations can result in huge losses. For example, China holds huge U.S. dollar-denominated assets, but if the U.S. dollar weakens on the exchange markets, the decline results in a relative loss of wealth for China. In addition to fluctuations in exchange rates, the purchasing power of fiat money decreases constantly due to devaluation through inflation. Therefore, a central bank must continually increase the amount of its reserves to maintain the same power to manipulate exchange rates. Reserves of foreign currency provide a small return in interest. However, this may be less than the reduction in purchasing power of that currency over the same period of time due to inflation, effectively resulting in a negative return known as the “quasi-fiscal cost”. In addition, large currency reserves could have been invested in higher yielding assets.