In "Yen and Yang", the Economist puts on its FX trader cap and explains why it believes the Yen is the most undervalued major currency in world. While artificial undervaluation is partially blamed on the Japanese government's "quantitive easing" as well as the infamous Yen Carry Trade, The Economist believes that there is more to it than this. In a sentence, the Yen is undervalued by 35% vs. the Euro... but it could be awhile before this changes. But perhaps its also worth reading the whole article. It divides currency movement into the concept of "upstream and downstream"...
why the yen is so feeble against the euro: the “global funnelling hypothesis”. This focuses on the net trade and capital flows of Asian and oil-exporting countries, which could run a combined current-account surplus of around $900 billion this year. In simple terms, the world buys from these countries and they then invest the net proceeds in financial markets.
Most international trade is settled in dollars or euros, so importers have to sell their local currencies in order to buy from abroad. Mr Jen calls these “upstream currency flows”. “Downstream flows”, in contrast, are what Asia and oil exporters do with their accumulated reserves. The currency compositions of the two flows do not necessarily match.
Because Asian countries trade a lot with each other, the bulk of upstream flows involves the selling of yen and other Asian currencies. In contrast, most downstream flows go into dollars and euros. Central banks prefer to put money into well-developed financial markets, so the liquid and secure markets of America, the euro area and Britain attract more capital.
This causes a funnelling from Asian currencies into dollars and euros. Emerging economies' rising foreign reserves therefore push the yen down against the euro, regardless of fair-value calculations. This also explains the strength of the pound. Recent figures show that it has knocked the yen off its perch as the world's third most popular reserve currency.
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