One of the most surprising developments of the financial crisis and recession has been the continued strength of the Japanese Yen.

The return of relative stability to the world financial system has not prevented the yen from retaining the majority of its crisis induced advances. The Japanese currency has held onto about 75% of its gains against the dollar, 65% versus the euro, 60% from the aussie and 75% from the sterling. In comparison the dollar has retained only 47% of its euro gain, 33% of its aussie improvement and 56% of its sterling take.

From its pre-crisis lows late last summer the yen appreciated 21% against the dollar, 34% against the euro, 47% versus the aussie and 53% opposed to the pound. The dollar also improved dramatically, gaining 23% against the euro, 39% versus the Australian Dollar and 32% against the pound.

The dollar and the yen were the only major currencies that strengthened during the crisis and that alone gave de facto status to each as a safe haven currency. But as the dislocations in the financial system have lessened so has the safe haven benefit to the dollar. Not so, or not nearly so much, for the yen. Why has the Japanese currency retained more of its crisis enhanced quality?

At the height of the crisis enormous quantities of Treasuries were purchased by panicked investors. The demand for dollars to buy those US instruments was one of the driving forces behind the greenback's ascent. But as the acute phase of the crisis has ebbed, the funds placed in the safety of T-Bills, Notes and Bonds have gradually left the United States seeking more remunerative investments elsewhere.

The effect on the dollar has been plain and predictable. Close to half of its crisis gains have been lost. The rationale for the dollar's rise and fall in response to the financial crisis has been logical, determined by the balance between the need for safety and earning, risk and return.

If the rise in the yen was due to the same influx of safety seeking funds, one possible explanation for the subsequent improvement of the yen is that the owners of those funds find in Japan a congenial investment environment.

Perhaps investors expect the Japanese economy to recover earlier than the United States or Europe. Japan is still the second largest economy in the world and its position in Asia and as a supplier to China, the largest industrial country to sustain strong economic growth, could help restore the Japanese economy. But in reality the Japanese economy has been underperforming for more than a 15 years throughout the economic rise of China. Japanese decline is largely due to internal factors, including expensive and protected consumer and agricultural sectors, bureaucratic and regulatory control of much of the economy, pointless and never ending domestic spending and a stultified political system that inhibited most change.

Then perhaps the victorious Democratic Party of Japan (DPJ) will be able to revive the economy and move the country into the 21st century?

Yet the policy prescriptions of the DPJ do not give the impression of de-regulatory pro-growth, consumer centered plans for Japan's economy. Japanese public debt is the highest in the industrialized world at 170% of GDP. Yet the election platform of the DPJ, with its Keynesian emphasis on government spending and its vague anti-capitalist and anti-globalization stances seems particularly ill-suited to reviving the world's largest export dependant economy.

When the vagueness of the DPJ economic policies is coupled with the inexperience of their legislators and the opposition of the long serving bureaucrats that really run the Japanese economy the promise for reform and restoration becomes even more problematic. It is very hard to discern a positive yen aspect from the prospective DPJ economic policies.

If the prospects for the Japanese economy have not fortified the yen then perhaps the currency has been supported by its ostensible role as a proxy trade for the Chinese Yuan?

When the financial crisis struck the Beijing Government ended the managed appreciation of the yuan; it has been static against the dollar since last fall. Did the yen play a substitute role to the Chinese currency with traders keeping long positions in the yen as a replacement for the unavailable yuan? While it is true that the end of yuan appreciation and the advent of yen strength coincide, it is more likely that the proxy currencies for the yuan are the Australian and New Zealand Dollars, which have had strong upward moves largely tied to the success of the Chinese economic stimulus.

If the strong yen is not a predictor of an economically recovered Japan and if its yuan proxy quality is limited, what are the remaining reasons behind its supposed safe haven status?
The idea of the yen as a safe haven currency can be ascribed to two factors. First the likelihood of Japanese default is very low and when tied to Japan's recent history of deflation Japanese bonds provide the investor with safety of funds and currency stability. Logically Japan could serve a secure repository for cash. That was also the position of the dollar and its issuer the United States Government. Both currencies scored highly in the financial crisis.

The second factor applies only to the yen and might be called the empirical choice; the yen rose during the financial crisis therefore it was a safe haven currency. By any measured judgment the yen is an unusual choice for a safe haven currency. Except for the unity of the Japanese political system most other economic and interest rate factors would seem to be against it. The Japanese economy has performed dismally over the past 15 years and Japan has one of the oldest and most rapidly declining populations in the world. Its potential for economic growth has been so limited that the Bank of Japan has not had its base rate over 0.5% since 1995.

But the financial crisis played a stronger hand than comparative economics. The worldwide collapse in interest rates destroyed the rationale for the carry trade. The result was a vastly strengthened yen because the attendant trade to the selling of the yen crosses was the panic buying of the yen against the US Dollar. As the carry trade loans came home to Japan and the speculative positions in the yen crosses vanished with the credit lines of the hedge funds, the yen was bought extensively but mostly to close existing positions. Once the loans and trading positions were covered there was far less speculative positioning against the yen than would be found in a normal market.

The equation of a stronger yen with financial turmoil was not due to the inherent strength and security of the Japanese economy but to the bubble markets in the carry trade and yen funding. The yen did not rise because traders sought the safety of Japanese investments. The yen rose because the currency markets were overwhelmed by the unwinding of the carry trade and yen funding positions.

But from an empirical view the yen appreciation coincided perfectly with the deepening of the financial crisis. It certainly appeared that the yen was being sought as a safe haven currency. And since the yen had strengthened it became, in fact if not in economic logic, a safe haven currency.

Yen strength, to borrow a phrase, prospered in a fit of absence of mind. The tremendous force of the deleveraging carry trade raised the yen to its current heights. But those forces were one way, buying the yen to close shorts but not opening new long positions which would later have to be reversed in their turn.

During the financial crisis the yen was not a safe haven currency. With the ending of the crisis the yen has not returned to pre-crisis trading levels. The evidence that there were few safe haven flows into the yen is simple; none have left Japan to weaken the yen with the crisis abatement.

For the dollar, a true safe haven during the crisis, the flows that entered during the crisis have now largely left. The dollar was boosted by the flows in and declined as they departed. The yen became a safe haven only by a trading default of the yen crosses.