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Japan once celebrated a cheap yen. Now, the worst currency crash in 20 years is causing widespread panic

April 22, 2022, 2:54 PM UTC

In the five-year interlude between his graduation from law school and his decision to follow his father’s footsteps into politics, Japanese Prime Minister Fumio Kishida was employed by the Long-Term Credit Bank of Japan, then one of the world’s largest lenders. His first posting was in the foreign exchange department. 

It is unclear whether the insights Kishida acquired in that first job have aided him in his current one. But what is clear is that exchange rates—more specifically, the sharp, sudden depreciation of the yen—are becoming one of the Japanese leader’s biggest headaches.

The value of the Japanese currency has declined more than 12% against the dollar over the last two months. As of late Friday in Tokyo, the yen was trading at 128 to the U.S. dollar, after breaching a 20-year low of 129 to the dollar on Wednesday. Among major currencies, only the Russian ruble has fallen further than the yen since the beginning of the year. And analysts warn that, for a combination of complex economic and political reasons, the yen is almost certain to continue its descent in the weeks and months to come.

Historically, Japan’s political leaders have welcomed a weaker yen as a boon for the world’s third-largest economy. In theory, a decline in the yen relative to the dollar increases the competitiveness of Japanese exporters in overseas markets and boosts the value of their profits when that money is repatriated back home. But Japan’s government and business leaders seem spooked by the yen’s recent decline. They say the yen is falling too fast, and complain that the currency’s weakness is driving up the cost of imports, including oil, raw materials, and food. Consumers are worried, too. With an important legislative election looming, Kishida is coming under intense pressure from business leaders and political allies within his Liberal Democratic Party to do something to halt the currency’s fall. 

And yet analysts say there’s not much Kishida can do without the cooperation of Japan’s trading partners, especially the U.S., as well as that of Japan’s own central bank. For now, none of those parties seems inclined to pitch in.

Over the past two weeks, as the yen’s slide accelerated, Japanese Finance Minister Shunichi Suzuki has ramped up his expressions of alarm. On Tuesday, he issued his most explicit warning yet about the dangers of the currency’s slump, declaring that the damage inflicted on Japan’s economy by a weakening yen would far outweigh any benefits—not least because Japanese companies won’t be able to pass the rising costs of oil and other imports on to domestic consumers. 

“In a situation like now when companies have yet to sufficiently raise prices and wages, a weak yen isn’t desirable,” Suzuki said. “In fact, it’s a bad yen decline.”

Masakazu Tokura, chairman of Keidanren, Japan’s largest employers’ federation, echoed that lament. “In the past when the yen weakened, trade balance, current account, and the economy were all good. It’s no longer that simple,” Tokura said. 

Even Fast Retailing CEO Tadashi Yanai, whose company operates more Uniqlo apparel shops overseas than in Japan, has bemoaned the yen’s decline. “There is absolutely no merit to a weak yen,” Yanai told reporters in an April 14 appearance during which he announced that Fast Retailing, buoyed by strong sales growth in North America and Europe, posted record profits in the six months ending in March. “Japan is engaged in the business of importing raw materials from all over the world, processing them, adding value to them, and selling them,” Yanai said. “In this context, there is no advantage if the value of a country’s currency weakens.” 

A December survey of nearly 7,000 companies by Tokyo Shoko Research found that almost 30% of companies said a weak yen was a negative for their business, while just 5% said it was a positive. A recent Reuters poll found that more than three-quarters of Japanese firms believe the yen has declined to point of being detrimental to their business.

Analysts attribute the yen’s decline to a global mismatch in monetary policy. While most other countries around the world are raising interest rates to counter inflation, the overriding concern of Japan’s central bank remains deflation. The U.S. Federal Reserve, which last month approved its first rate increase in three years, has said it will raise interest rates as many as six more times this year. In contrast, the Bank of Japan, which has held Japanese interest rates near zero (or less) for nearly a decade in an effort to stimulate demand, insists Japan’s economy remains too anemic to abandon the bank’s ultra-loose rate policy yet.

The divergence in policy reflects fundamental differences in the health of the U.S. and Japanese economies. The U.S. has come roaring back from the pandemic. In March, the U.S. consumer price index rose by 8.5% from the same month a year ago, the fastest annual gain in 40 years. The Japanese economy is still struggling to recover from the ravages of the pandemic and grappling with long-term problems like a shrinking and aging labor force. On Friday, the government announced that Japan’s consumer price index rose 0.8%—a 26-month high but still far short of the 2% inflation rate set by Bank of Japan governor Haruhiko Kuroda as the threshold for raising rates.

“When investors can make more money by investing in American bonds…rather than bonds in Japan, they shift money from Japan to the U.S.,” explains Richard Katz, a veteran analyst of Japan’s financial system, in a recent newsletter. “As they do so, the law of supply and demand sends the yen downward.” 

Indeed, as Katz points out, in September, when the gap between interest rates on 10-year U.S. Treasury bonds and Japan government bonds was 1.3%, the yen was worth 110 yen to the dollar. Now, with the rate gap widened to nearly 3%, the yen has plunged.

Kuroda has said he agrees with Suzuki that the speed of the yen’s fall is too “sharp.” But unlike the finance minister, he insists the weak yen is a “net positive” for Japan. On Wednesday, the Bank of Japan underscored its commitment to preventing a rise in long-term interest rates by announcing that it would offer to buy an unlimited amount of Japanese government bonds at a fixed rate. 

If Kishida and Suzuki can’t persuade Kuroda and the Bank of Japan to follow the Fed’s lead by raising Japanese interest rates, they have another option: the Ministry of Finance could attempt to strengthen the yen by wading into global currency markets to sell dollars and buy up yen. But history suggests such interventions almost never work unless they are conducted with the support of the U.S. and other Group of Seven (G7) economies. As Katz notes, the last time Japan’s finance ministry took on global currency markets unilaterally—during a 15-month battle launched in January 2003—the government spent $320 billion only to surrender with the Japanese currency 9% higher than when the intervention began.

And while Japan occasionally has intervened in currency markets to prevent the yen from strengthening, it hasn’t done so to prevent its currency from weakening since 1998, when the Asian financial crisis triggered a region-wide selloff.

Suzuki and Kuroda both traveled to Washington this week to attend a meeting of finance ministers and central bank officials from the G7 and Group of 20 (G20) nations. Suzuki met separately with U.S. Treasury Secretary Janet Yellen. TBS, a Japanese television broadcaster, reported Friday that the two finance leaders discussed the idea of coordinated currency intervention to arrest the yen’s decline, according to Reuters. The TBS report quoted a Japanese government source as saying that “the U.S. side sounded as if it would consider the idea positively.”

But Suzuki was far less forthcoming in his official description of the discussion. Speaking to reporters after the meeting, he declined to comment on whether the two had spoken about currency market intervention, adding only that he and Yellen “confirmed that currency authorities of both countries will communicate closely, aligning with the exchange rate principles agreed among the G7 and G20.” 

Investors remained skeptical that Washington would support Japan’s call for intervention. The yen hovered around 128 to the dollar after the TBS report. 

The G7, in a statement issued Thursday, said finance chiefs were monitoring markets that had been “volatile,” but made no mention of exchange rates at all. There was irony in that omission. The G7 was created in the wake of the Plaza Accord, the September 1985 agreement that Harvard University economist Jeffrey Frankel has hailed as “probably the most dramatic policy initiative in the dollar foreign exchange market” since Richard Nixon took the dollar off the gold standard in 1973. Under terms of the accord, named for the New York hotel where it was signed, the world’s largest industrialized economies agreed to bring down the value of the dollar through a coordinated campaign to sell dollars in exchange for other currencies. By some measures, that intervention was a success. After two years, the dollar was 40% weaker than when the agreement was signed. The U.S. trade deficit declined, and Congress backed down from threats to enact protectionist trade barriers.

But an unexpected consequence of the agreement is that the Japanese yen appreciated sharply against the dollar—far more than did the European currencies. The sudden surge in the value of the yen—known in Japan as the endaka shokku or strong yen shock—forced a radical restructuring of Japan’s economy. To survive, many of the nation’s largest manufacturers, including in the automobile and electronics industries, shifted large swaths of their production processes overseas.

Japan’s current ambivalence to the yen’s sharp decline is, in many ways, a legacy of the transformations the Plaza intervention set in motion. Exports now make up only about 15% of Japan’s economy—the smallest contribution to GDP of all nations in the Organization of Economic Cooperation and Development except for the U.S. About two-thirds of all cars sold by Japanese manufacturers are produced outside Japan, according to Reuters calculations based on data from the Japan Automobile Manufacturers Association. Two decades ago, cars made overseas accounted for less than 40% of Japan’s auto sales. Nearly a quarter of Japanese manufacturers rely on some form of overseas production, according to a 2020 survey by Japan’s Ministry of Economy, Trade and Industry. Only 17% of manufacturers produced offshore a decade ago. The result is that a weak yen no longer brings the same benefits that it used to for Japan.

As a junior banker in the 1980s, Kishida could not have foreseen the magnitude of the changes the Plaza Accord would unleash upon the bank’s giant manufacturing clients—and the bank itself. (Long-Term Credit Bank, unable to adjust to changes in Japan’s banking sector that evolved from the currency agreement, collapsed in the 1990s and was taken over by a U.S.-led investment consortium.) But it is remarkable nonetheless to see the leader of a country once considered the world’s most formidable export juggernaut now appealing for global cooperation in propping its currency up rather than driving it down.

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