A few dollars more.
July 30, 2011 7:28 AM   Subscribe

Is there a rational upper limit or ceiling on the value of currencies, such as the yen, which have experienced substantial increases against the dollar due to the US debt crisis?

For most amateurs, speculating on currencies is a fool's errand. Trying to predict the value of a currency a month, a week, even a day from now is nearly impossible, even using advanced mathematical or statistical models and software technologies.

That said, lately, some currencies have experienced massive increases against the dollar due to the debt crisis. The yen is within a hair's breadth of setting an all-time record against the US dollar. If it breaks through the rate of 76 yen to the dollar, we'll be entering new territory--and most likely confounding many economists who never predicted this value decades ago.

After responding to pressure for a floating currency from the Nixon administration, the yen climbed from 300-yen-to-the-dollar in the seventies, breaking the 200-yen-to-the-dollar barrier in the early eighties, and steading around the 100 mark in the aughts. Now, it's at 77. Is there an end in sight? Is there a rational ceiling at which it can't continue to rise against the dollar? If so, where might we expect this ceiling to be in numerical terms? What economic or geopolitical factors would fortify this ceiling against further increases?
posted by Gordion Knott to Work & Money (5 answers total)
If the USD becomes worthless all other currencies will be infinitely more valuable than it. That--infinity--is the upper limit.

The probability of that happening is as close to being 0 without actually being 0 as you can get.
posted by dfriedman at 8:09 AM on July 30, 2011

Lay answer - no, there is no ceiling beyond which it can't rise, or more correctly, there is a ceiling (market equilibrium) but there is not a limit on the height of that ceiling - it is up to the non-rational actors of the marketplace.

As the yen (and other currencies) rise, I would expect market resistance to further rises to increase until a new equilibrium is reached as, for example, more people start to want to trade their yen for dollars so that they can buy assets and goods from the USA at firesale prices due to the exchange rate.
posted by anonymisc at 8:12 AM on July 30, 2011

There's a huge gap between the mainstream theory about how this works, and how it actually works.

In theory, fluctuations in the values of currencies help to balance trade over time. The dollar is strong, so Americans import a lot of goods, and this drives down the value of the dollar. That makes imports more expensive in the US, and helps American exporters, and domestic producers. So the invisible hand smoothes things out.

In practice the value of currencies have a lot to do with speculation, and central bank policies. The US is also a sort of special case, because dollars have been the primary international reserve currency. The dollar has been kept stronger than market forces would justify for a long time now. That's how the US has been able to run huge trade deficits over a long period.

In the case of Japan, I believe there are powerful business interests that want the dollar to stay strong against the yen. Japan has big exporters like Toyota, Sony, etc... Japan's central bank has large dollar reserves -- second largest after China, as I remember -- which it would have accumulated in order to keep the Yen weak.

To try and answer your question, the huge amount of money that's used to speculate on currencies makes their behavior really unpredictable in the short-term. Speculation is one of those feedback loops in which prophecies become self-fulfilling. So even if you could say what the US dollar _should_ be worth against the yen, it's really unlikely that it would go to that value. It's more like a big weight balanced on a sharp point: it tends to wobble around, but if it tips too far in one direction then speculation can keep pushing it that way very fast.

You might be interested in the 1997 Asian Financial Crisis as a historical comparison.
posted by Net Prophet at 8:15 AM on July 30, 2011 [1 favorite]

It's all relative. Every currency's gain is another's loss, there are many stories of nearly worthless currency that has to be brought to the grocery store in wheelbarrows. If you're experiencing something like that, where your local currency is a million-to-one against the Franc or Dollar or whatever, those other currencies would seem to have sky-high value.

If the yen achieves 1:1 parity with the dollar, that also means the dollar is losing value, and the scale just starts sliding the other way for the dollar. 300:1 now? 1:6 (1:300?) in 10 years. It's a big see-saw.
posted by rhizome at 8:17 AM on July 30, 2011

Net Prophet gives a great answer, but I want to chime in with a little thought experiment.

Monetary policymakers have a (very, very rough) control over the inflation rate of their currency. If the Fed wanted to, it could institute a new round of quantitative easing large enough to push inflation up to 10% a year or so (of course, this is not a good thing for the economy, but it could be done). This would rapidly push up the value of the Yen against the dollar, because the supply of dollars would be rapidly expanding while the supply of Yen would hold steady.

Which is to say, exchange rates are just numbers, pushed around by a lot of underlying factors, but they have no meaning in and of themselves.
posted by _Silky_ at 11:32 AM on July 31, 2011

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