The yen – Japan’s currency – has just hit a 20-year low, standing at an exchange rate of ¥130 to $1 USD for the first time since 2002. A low, or devalued currency is one whose value has decreased in comparison to others and thus has less purchasing power.
Though welcomed in the past, a weak yen is now a cause of concern. A devalued currency once made Japanese goods cheaper for foreign buyers, which helped boost exported goods such as cars and electronic equipment. But now, a rapidly weakening yen is hurting firms and households given inflated global prices. Sudden supply chain shifts caused by the Russian invasion of Ukraine inflated fuel and raw material costs, and a weaker yen has amplified the problem by making imported goods more expensive. Once a positive development, a weaker yen has become an economic burden for Japan as it tries to navigate its position in the globalized economy.
A Downward Spiral?
The reason for the yen’s rapid fall lies in a wide interest gap between Japan and the U.S. In March 2022, the U.S. Federal Reserve announced its plans to raise interest rates as much as six times this year, while the Bank of Japan clarified having no plans to change its ultra-low rates. Investors hoping for a profit began shifting money from Japanese bonds to U.S. bonds because it yielded higher returns thanks to higher interest rates in the U.S. Since these bonds can only be bought with the currency of the country issuing them, investors sold huge amounts of yen in exchange for dollars in the foreign exchange market. The demand for the yen plummeted, and the yen’s value quickly dropped against the dollar from March to late April.
What’s more, the yen is expected to weaken further. Announcements by Japan’s central bank indicate that the interest rate gap between the U.S. and Japan will only continue to widen. In late April, the Bank of Japan shut down speculation among investors about possible intervention, sticking strongly to its original stance of keeping interest rates ultra-low. Knowing that interest rates in Japan will stay low while the U.S. raises them has prompted investors to sell the yen, creating more fear that the yen will continue to fall.
Despite this, it’s difficult to pinpoint exactly why there hasn’t been government intervention to address the falling yen. Neither the Bank of Japan nor the Ministry of Finance, who hold the tools to influence the exchange rate, have commented on their inaction. However, one can speculate that Japan isn’t intervening because options to fight a weak yen – raising the interest rate and intervening in the foreign exchange market – are costly.
Why Doesn’t Japan Just Raise the Interest Rate?
Since the interest-rate gap is the main cause of the weakening yen, a logical assumption is that Japan can just close the gap by raising interest rates. Authorities do this by selling a variety of bills issued by the central bank and the treasury, which shrinks the supply of money and raises the interest rate (a process known as open market operations).
However, simply raising interest rates would have a negative effect as it would slow down Japan’s economic recovery. Japan’s GDP is still below pre-pandemic levels by 2%, after heavy restrictions on dining and travel reduced consumer spending. Raising interest rates in such an environment would stunt GDP growth – by making it more expensive to borrow money, consumer spending would be discouraged. “Given the developments in Japan’s economy, it is necessary and appropriate for the Bank to continue with monetary easing and thereby firmly support the economy,” stated Bank of Japan Governor Haruhiko Kuroda in a speech. Thus, the need to maintain a low-interest environment for economic recovery takes priority over raising interest rates to strengthen the yen.
Additionally, an interest rate hike, in this case, wouldn’t actually be in line with the central bank’s mandate. The Bank of Japan’s mission is to change interest rates to control inflation, not foreign exchange rates. But when looking at Japan’s inflation rate, it isn’t high enough to warrant a policy change. Current inflation levels in Japan stand at 0.5-1%, well below the 2% level that prompts an interest rate hike. Unlike the U.S. which pushed up interest rates soon after inflation levels hit 8.5%, Japan isn’t yet at the point where an interest rate hike would be approved. Kuroda confirmed this stance by stating that inflation will trigger policy change, not yen weakness. In sum, Japan ruled out the option of an interest rate hike because not only would it sabotage economic recovery, but it also is unnecessary based on central bank standards.
Why Not Buy More Yen on the Foreign Exchange Market?
Intervening in the foreign exchange market is another option to stop the yen from falling further. Japan can strengthen the yen by increasing demand for the yen, or in other words, by buying massive amounts of yen. Authorities do this by taking U.S. dollars from foreign reserves and selling them in exchange for yen in the foreign exchange market.
The Ministry of Finance has not initiated a yen-buying intervention, however, because it is costly. To buy yen, Japan must use dollars from its own foreign reserves. Although Japan is the second-largest holder of foreign reserves, it could quickly shrink if huge sums are required to keep the yen strong. Losing too many foreign reserves would hurt its ability to pay external debts and have backup funds in times of crisis. “Of course, they [the Bank of Japan] could have intervened but it’s really a waste of time and resources,” wrote Bipan Rai, a top strategist at the Canadian Imperial Bank of Commerce, in a note.
On top of being costly, intervention might also not work in the long term. Intervention has a high chance of failure because it doesn’t tackle the main cause of the weak yen – the interest-rate gap between the U.S. and Japan. Tweaking the foreign exchange rate would leave interest rates in both countries untouched. Seeing that higher interest rates in the U.S. still bring higher returns, investors would continue selling yen for dollars, weakening the yen again, all the while Japan loses precious foreign reserves.
When asked whether Japan should conduct yen-buying intervention, senior International Monetary Fund (IMF) official Sanjaya Panth said that the yen’s declines have been driven by economic “fundamentals” and would be no reason for Japan to change its policy. Panth states that currency intervention wouldn’t work because it doesn’t affect interest rates in the U.S. or Japan, the fundamental factor driving the yen’s weakness.
The last factor that adds to the difficulty of currency intervention is the need to get permission from other countries. Currency intervention requires informal consent by the G7, especially by the U.S. since it would be conducted against the dollar. This would be difficult to execute since the U.S. Treasury is traditionally opposed to the idea of currency intervention, stating that disorderly market conditions have to be in “exceptional circumstances” to warrant help. “It’s likely very hard for Japan to gain any support for intervention from overseas,” said economist Harumi Taguchi from S&P Global Market Intelligence. The risk of depleting foreign reserves, the risk of backfire, and the need for consent all make currency intervention a costly option.
Too Deeply Embedded in the Global Economy
Since neither interest rate hikes nor currency intervention is a practical option, Japan has made its last-resort attempt to counter the falling yen: verbal intervention. When a currency weakens too much, bank officials try to “talk up” the currency by expressing concern. Worrying language hints to investors listening closely about future policy changes, allowing bank officials to influence the exchange rate without the risks of actual intervention. Governor Kuroda has gradually escalated his language to express more concern for the falling yen. While he had been long calling the weak yen a “net positive” for the economy, he is now describing the fall of the yen as too “sharp.” After Kuroda’s remarks, the yen strengthened slightly against the dollar as intended, but this method has been mostly ineffective since the effect wore off soon after.
Japan’s inaction toward the weakening yen likely comes from costly alternative options. But perhaps this inaction reflects a deeper shortcoming of a global currency. The yen’s deep attachment to the global economy makes it easily influenced by other countries’ policies. Economic policies in the U.S. affect Japan more than they ought to because the yen is the go-to funding currency for investors who use it to purchase dollars, a currency that typically has a higher interest rate. Japan is also dependent on other countries for permission to save its population from inflating prices. This is problematic because Japan effectively cannot control its own currency.
We should also be asking ourselves why the IMF supports the status quo when the organization is long-known to be a supporter of U.S. interests. While Panth advocates for Japan’s non-intervention by arguing that the weak yen reflects economic “fundamentals,” a low-interest environment is also more attractive to American and other multinational corporations. When a policy of inaction affects millions of firms and households, we should question if this is really the best course of action for the people.
Edited by Majeed Malhas