The Japanese yen has been in free fall this year, losing 10% of its value and hitting 20-year lows.
There are several causes for the plunge and it isn’t clear that Japan’s monetary authorities can do anything about it. Authorities have maintained their loose money policy, prompting questions about how eager they are to stop the decline. A weak yen has served Japan well; an unstable currency does not.
The yen’s deterioration has made it the worst-performing major currency this year in dollar terms. The Japanese currency surpassed ¥129 to the dollar this week before falling back to ¥128. A few weeks ago, there were fears that it would challenge the ¥130 mark; foreign exchange analysts now believe that ¥135 to the dollar could be breached in the near future.
There are a couple of explanations for the yen’s fall. The first is rising commodity prices. When Japan spends more on the goods it needs to power its economy, it uses dollars to pay for those imports. When imports eclipse exports in value, the demand for dollars depresses the value of the yen. Japan has experienced monthly current account deficits before and the recent imbalances are thought to be the product of temporary phenomena: the pandemic and the war in Ukraine.
But those deficits have historically been of short duration; the last time the country had a deficit over the course of a year was in 1980. Most observers believe that the country is experiencing a structural change in its economy as a result of demographic change and the offshoring of production networks, and an annual deficit will become a regular occurrence. A steady and regular outflow of money is a drain on the economy and a sign of a fundamental problem.
A second explanation is the Bank of Japan’s loose money policies, most evident in its ultralow interest rates. Japan has been trying to spur inflation for decades as flat prices depress spending, undermine innovation and lead to economic stagnation. Monetary authorities here have tried to get inflation to the 2% level to encourage a healthy level of spending and growth. Despite the adoption of unprecedented and unorthodox policies, inflation remains well below that target.
Elsewhere, inflation is reaching generational highs, however. To fight that trend, monetary authorities in the United States, the European Union and England have increased interest rates. The U.S. Federal Reserve is widely expected to raise interest rates by 50 basis points next month, a move that will, when taken in conjunction with the decision to slow the acquisition of assets that it has been buying to support the economy during the pandemic, cause interest rates to spike. The widening gap makes dollar-, euro- and pound-backed assets more attractive to investors, prompting them to sell yen.
Normally, Japanese officials favor a weak yen because it helps Japanese companies earn higher profits. Their goods are more competitive in foreign markets and they still make more money when they remit those sales, which are invoiced in dollars. But Japanese businesses now rely increasingly on foreign production, which limits the value of a weaker yen to their bottom line.
Worse, higher import prices hurt both producers and consumers. Inputs for domestic production are more expensive, cutting profits. The most obvious example is rising power bills: Tokyo Electric Power Co. has raised the electric bill for a typical household to ¥8,505 in May, while Tokyo Gas will raise rates to ¥5,784, 25% and 24% rises, respectively.
Japanese authorities are concerned. Finance Minister Shunichi Suzuki called the pace of the yen’s decline “undesirable” and said his ministry is “monitoring the situation with a sense of urgency.” Haruhiko Kuroda, governor of the Bank of Japan, has said that the sharp fall in the value of the yen will have a “negative effect.” Prime Minister Fumio Kishida is probably most worried; the last thing he wants as he faces an election this summer is rising prices that hurt voters.
In truth, however, signals are mixed. Financial officials want stability and flatter curves in exchange markets; but look closely at Suzuki’s comments and the emphasis seems to be on the angle of the decline in the yen — the speed — rather than the direction. Meanwhile, Kuroda insists that a weak yen is good for Japan, believes that inflationary pressures are just temporary and refuses to move away from the low-interest rate policy. Market skepticism about Japanese policy is understandable, which reinforces current trends.
Given their size and volume, the only way that currency markets can be impacted is through coordinated intervention by the major economies. But economists believe that the gap in interest rates reflects differing conditions among major economies. Prices are going up here, but inflation in Japan is nothing like that in the U.S. or Europe. As an official at the International Monetary Fund noted, the yen’s value is being determined by market fundamentals — different growth rates and price levels.
The belief that the yen’s value is a product of fundamentals means that there will be no concerted action by the Group of Seven. Even a joint statement by Japan and the U.S. would be insufficient to change the existing momentum.
Investors know that and discount talk of slowing the yen’s decline. Politicians must hope that inflation will prove temporary and that its impact contained — at least until after the summer election. But structural change in the Japanese economy will continue — and the need to adapt will intensify. Old thinking will have to go, and the idea that a weak yen is the answer to Japan’s economic ills will be a likely casualty.
The Japan Times Editorial Board