Currency traders betting on a rebound in the yen would be wise to look past the officials currently in charge and listen instead to policy veterans who know better.
Over the last year as the yen was recording three-decade lows, officials such as Finance Minister Shunichi Suzuki, top currency diplomat Masato Kanda and Bank of Japan Governor Kazuo Ueda pinned the currency’s plunge on Federal Reserve decisions in Washington – the idea being that the yen is a victim of the Japan-US yield gap.
This is bunk, as Hiroshi Watanabe, former vice minister of finance for international affairs, tells Nikkei Asia. Even if Tokyo intervenes again, there’s little scope for the yen to rally from 159 now past, say, 150 to the US dollar, he says.
The odds favor an ever-weaker yen in the weeks ahead. The reason: Tokyo’s 25-year-old weak-yen strategy is blowing up on Asia’s second-biggest economy in real time, leaving the currency on a downward path.
“The scale of yen depreciation in recent years is startling,” says Robin Brooks, economist at the Brookings Institution. “The yen has fallen more in real effective terms than the Turkish lira, which long held the distinction of being the weakest currency across the major markets. Indeed, since the end-2019 – since just before Covid hit – only one currency, the Egyptian pound, has fallen more than the yen in real terms.”
Brooks adds that, “not surprisingly, the scale of this depreciation has sparked debate on its drivers and how much further it can extend.” On some level, he explains, “yen weakness stems from Japan’s very high debt, which forces the bank to cap long-term government bond yields via open-ended bond buying.”
Ultimately, Brooks concludes, “Japan is a cautionary tale about letting debt rise unchecked. Countries can use their central banks to cap government bond yields, but that just transfers weak debt dynamics into currency depreciation.”
Now that Watanabe is out of direct government service – he’s running a Tokyo think tank – he can be blunt about why the yen shouldn’t be considered a safe-haven asset. And why the market bets that intervention by the Ministry of Finance won’t work.
Since the late 1990s, a succession of Japanese governments has pursued a weak-yen-only strategy to boost growth and defeat inflation. The gambit took on even greater importance after Japanese officials claimed they were moving beyond the beggar-thy-neighbor policies of the past.
The reference here is to late 2012, when the Liberal Democratic Party returned to power. Prime Minister Shinzo Abe roared back into office with a bold plan to revitalize the economy.
Abe employed a samurai metaphor about how firing three arrows at a target ensured success. Abe’s arrows, aimed at slaying deflation, included aggressive monetary easing, more creative fiscal policies and a deregulatory Big Bang.
Unfortunately, structural reforms to cut red tape, revive innovation and productivity, empower women and attract more top global talent were few and far between. Same story for plotting a new fiscal path. Debt has continued to explode over the last 14-plus years.
Instead, Abe prioritized lower interest rates and a weaker yen. In 2013, he tapped Haruhiko Kuroda as Bank of Japan governor to turbocharge the quantitative easing policy Tokyo had pioneered in 2001. Between 2013 and 2018, the BOJ hoarded bonds and stocks to the point where its balance sheet topped the size of Japan’s US$4.7 trillion gross domestic product.
Count the ways this strategy is backfiring. As the Fed tightened in 2022 and 2023, the yen’s weakness deepened. That left Japan highly vulnerable to rising prices of oil, food and other key imports.
“The ideal situation would be for wage gains to be passed on to prices and for prices to rise stably,” says economist Atsushi Takeda at Itochu Research Institute. Instead, “bad” inflation imported from abroad is undermining household and business confidence.
Goushi Kataoka, a former BOJ board member, notes that “cost-push pressure is heightening at a degree never seen before, prodding firms to raise prices.”
The yen’s decline also is taking on a life of its own. “As long as US-Japan rate differentials exceed a certain threshold, it is possible that yen selling due to carry trades will not decline even with some narrowing of rate differentials,” says Shinichiro Kadota, strategist at Barclays.
But the yen is down because of a lack of investor confidence in the currency. So far this year, the yen is down more than 13%. Its trajectory is fueling concerns that China might decide it, too, might benefit from a lower exchange rate. The yuan is nearing its weakest level since 2008.
There’s an argument that the deflationary pressures bearing down on China would best be addressed by a weaker yuan. But Japan’s experience is a cautionary tale of the costs of putting aggressive monetary easing above moves to increase competitiveness and good disruption.
The BOJ essentially launched history’s biggest political and corporate welfare scheme. It removed the urgency for the 13 governments since the late 1990s to recalibrate growth engines and level playing fields.
Corporate chieftains felt less pressure to innovate, restructure and take big risks. For two-plus decades, it’s been easier to harness BOJ support than for CEOs to disrupt industry. That BOJ-enabled complacency is now haunting Ueda’s BOJ team in 2024.
As Japanese policy veterans like Watanabe now admit, the yen is weakening anew because it’s the only policy Tokyo really has. This explains, in part, why Ueda has avoided any chance even just to start the process of normalizing rates. In his 14-plus months at the helm, Ueda has passed up every chance he’s had to signal change is coming.
Even if the MOF intervenes in the days ahead, the yen remains in secular-decline mode. The economy is losing momentum too quickly for the BOJ to feel comfortable tapping on the brakes. Nor is the political backdrop in Tokyo conducive to tighter policy.
The only thing falling faster than GDP is the approval rating for the LDP’s current Prime Minister Fumio Kishida, now 21%. The last thing Ueda wants is for the BOJ to be blamed for pushing Japan into recession. Yet the longer the BOJ keeps its foot on the gas, the lower the yen goes.
Kelvin Wong, senior analyst at currency broker Oanda, says that “softer prints of Japanese economic data may prompt BOJ to delay its next interest rate hike to September coupled with the near-term uptick in geopolitical risk premium coming out from the Eurozone due to the looming first round of French legislative elections scheduled this Sunday, 30 June that support potential bids on the US dollar due to safe-haven demand.”
Japan contracted 1.8% year on year in the January-March quarter. The one bright spot is exports, which are “having a positive impact,” says Yeap Jun Rong, market analyst at IG Asia Pte.
There’s an argument, though, that Japan’s economy is in worse shape than the official data suggest. Marcel Thieliant, economist at Capital Economics, points to hopes that exports alone will save the day.
“Most of the increase in trade values over the past year reflects rising prices due to the sharp weakening of the yen rather than any marked improvement in volumes,” he notes.
One wild card is the November 5 US election. If Beijing lets the yuan weaken, too, exchange rates could become a big controversy in Washington. No issue brings President Joe Biden’s Democrats and Donald Trump’s Republicans together like beggar-thy-neighbors gambits in Asia. That could add fresh fuel to trade-war politics in Washington, provoking retaliation in Beijing.
But for Japan to pretend that a sliding yen is all Washington’s fault is no more credible a claim than saying the policy is working. The preponderance of the data refutes both contentions.