Today the Japanese Central Bank intervened (for the first time in 6 years in international currency markets). BBC has the story:

Japan moves to combat rising yen 

The Japanese central bank stepped in to sell yen and buy dollars, a day after the yen hit a 15-year high against the dollar.

It is the first time in six years that the Bank of Japan has intervened, and further action has not been ruled out. A strong yen makes Japanese exports more expensive, and reduces profits when earnings are repatriated.

In early trading on Wednesday, the dollar rose to 85 yen, after hitting 83.09 yen on Tuesday. Investors welcomed the intervention, sending Japan's Nikkei share index up by 2.9% at first, with the index eventually closing 2.34%higher at 9,516.56.

Economic harm

But in a brief news conference, Finance Minister Yoshihiko Noda said: "We have conducted an intervention in order to suppress excessive fluctuations in the currency market. "We will closely monitor currency developments, and take firm action including intervention… The yen's rapid appreciation "harms the stability of the economy and finances. We cannot tolerate it."

Japanese exporters praised the intervention. "From the standpoint of aiding the competitiveness of Japan's manufacturing industry, we applaud the move by the government and the Bank of Japan to correct the yen's strength," carmaker Honda said in a statement. Honda's shares closed up4%, while Sony, another big exporter, ended 4.2% higher…  A recent government survey suggested many companies were considering moving production overseas if the yen stayed high.

The record low for the dollar is 79.75 yen, reached in April 1995. Mr Noda did not reveal the size of the intervention, although the Dow Jones news agency reported that Japan's Ministry of Finance had initially sold between 200bn and 300bn yen ($2.4bn-$3.6bn).

But who is buying the Yen? The Japanese economy has been anemic since the early 1990s (the Japanese stock index has fallen by roughly 66% in the last 20 years).

Source 

Ok, so the Chinese government has been buying Japanese bonds, but their $20 billion purchases this year, cannot be the whole story.  Reuter's makes an attempt to explain the recent movements using interest parity (yield spreads) and sterilization – none of it convincing.  The one interesting piece is that the REER has actually not moved much less than the nominal exchange rate because of Japanese deflation.

Here is a final thought: when will we hear about Japanese "Mercantilism?" 

The Wall Street Journal spells out the Love (Hate) triangle all its juicy details:

China has been diversifying its $2.5 trillion reserves away from the dollar, causing some to worry that less Chinese buying of Treasurys would cause U.S. interest rates to and make it more difficult for the government to borrow.

But Japan’s dollar buying in currency markets Wednesday shows Chinese reserve diversification might actually lead to even more demand for Treasurys.

Here’s how. As China diversifies out of U.S. dollar-denominated assets such as Treasurys, it is buying debt denominated in the currencies of some of its biggest trading partners. Not wanting to lose competitiveness themselves, those trading partners in turn buy dollars to keep their currencies cheap.

As part of the diversification push, China has been a major buyer of yen, snapping up $27 billion in yen so far this year according to Japanese Ministry of Finance. Analysts say China’s buying has helped an already strong yen get stronger.

Now, Japan, feeling under pressure to weaken its currency, turned around and bought dollars, most likely in the form of Treasurys. It isn’t clear exactly how much dollar buying Japan will have to do to protect the yen from getting stronger, but it’s likely to more than offset China’s diversification into the yen. If the past is a guide, Japan spent $320 billion in its last intervention from 2003 to 2004. And this time the currency markets are 73% far larger, with $568 billion dollar-yen trading a day,  according to the Bank for International Settlements.

Japan is not alone in this phenomenon. China has also bought South Korea’s currency, the won. And South Korea routinely intervenes in currency markets, buying dollars to keep its currency from rising too quickly, again offsetting China’s move out of the dollar.