Charting the yen's path: A tale of shifting fortunes

The yen (¥), Japan's official currency, has long held a position of prominence in the global financial markets. From its inception in the late 19th century to its role today as a major international currency, the yen has been both a symbol of Japan's economic prowess and a reflection of its challenges. One phenomenon that has dramatically impacted the yen's trajectory is deflation — a persistent decrease in the general price level of goods and services — a conundrum Japan has been grappling with for decades. This article delves into the multifaceted story of the sliding yen and its wide-ranging implications.

What causes the Japanese currency yen (¥) to weaken in value?

Deflation is the primary reason for the yen's weakening against other currencies. Japan's experience is distinct from the more common occurrence of inflation, where prices generally rise over time. The various factors fuelling deflation in Japan while hindering the country's ability to maintain a healthy inflation rate are explained below.

1. ‍Demographics: Japan's ageing population and declining birth rate result in a smaller workforce and reduced consumer demand, leading to lower income growth, decreased spending, and reduced demand for goods and services, all of which push prices down.
2. ‍High savings rate: Japan's tradition of saving a significant amount of money has its advantages, but also reduces spending on goods and services, contributing to deflation.
3. ‍Technological advancements: While technology enhances productivity, it can lead to oversupply in the market as production becomes more efficient, causing prices to drop.
4. ‍Psychological factors in deflation: When consumers and businesses anticipate continuous price declines, they may delay spending and investments, thinking they can get better deals later. This further reduces demand and keeps pushing prices down, creating a cycle of deflation.
5. ‍Global competition: Japan's role as a major exporter requires companies to keep prices low to stay competitive, adding to deflationary pressures.

The Bank of Japan's efforts to combat deflation through monetary policy, such as low interest rates and quantitative easing, have achieved some effects. Still, these measures have not always been sufficient to entirely eliminate deflation.

The upsides of a sliding yen

Despite its complexities, a sliding yen — a situation where the value of the Japanese currency decreases relative to other major currencies — can bring several benefits to Japan's economy and the global markets:

1. ‍Export competitiveness: A weaker yen not only makes Japanese exports more affordable in the international market — driving up demand for the country's products and bolstering export-oriented industries — but it also helps improve Japan's trade balance.
2. ‍Tourism and services: A devalued yen attracts tourists, as their money has increased purchasing power within the country. This benefits Japan's tourism sector and related industries.
3. ‍Inflationary pressure: A weakening yen can counter Japan's long-standing issue with deflation through the cost of imports. When imported goods are more expensive due to the yen's depreciating value, domestically produced goods and services may experience higher demand. Hence, domestic producers might increase their prices in tandem with the price of imported goods.
4. ‍Corporate earnings: Companies with significant foreign earnings would likely benefit from a sliding yen. Their foreign revenue converts into more yen, leading to improved corporate earnings.
5. ‍Stock valuations and stock prices: A weaker yen, coupled with increased export sales, favourable exchange rates, and Japan's stellar reputation for good corporate governance, has made Japan an attractive region for investment in Asia. Additionally, Japan's relatively low-interest rates, compared to the rest of the world, encourage investors to seek higher returns in equity markets rather than lower-risk fixed-income assets.

Consequently, all these factors contribute to higher stock valuations and prices in Japan. In June 2023, Bloomberg reported that the Nikkei 225 (also known as the Japan 225) had risen for the 10th consecutive week, marking the longest streak in a decade.

Navigating the complexities

However, a sliding yen comes with its share of challenges.

Over the past two years, as global inflationary pressures have significantly increased, exacerbated by the Ukraine crisis, Japan has embarked on a substantial budget stimulus programme to defend its yen and address economic uncertainties.

This was necessary because Japan heavily relies on imports, as its companies have moved production overseas in the last few decades due to shrinking economic growth and an ageing population. Balancing imported inflation and local deflation and avoiding interest rate hikes were crucial to support the yen and ensure ongoing economic growth.

Apart from verbal interventions, where authorities escalated their warnings and promised "decisive action" against speculative moves, the Bank of Japan has intervened directly in the foreign currency market by buying large amounts of yen, usually selling dollars for the Japanese currency. This ongoing massive stimulus programme defended the yen in September last year when the Bank of Japan sought to stem a 20% decline against the dollar this year amid a widening policy divergence with the US. According to Bloomberg, this happened for the first time since 1998.

Yen-buying intervention poses more significant challenges than yen-selling intervention. Japan's substantial foreign reserves, amounting to approximately 1.3 trillion USD, could be significantly depleted through sustained large-scale yen purchases. This implies that there are limits to how long Japan can keep defending the yen, in contrast to the yen-selling intervention, where Japan can effectively increase the yen supply by printing or issuing bills.

Another option would be the Bank of Japan raising interest rates to defend the yen's valuation. In a recent September 2023 interview, Bloomberg reported that a member of the Bank of Japan's policy board, Hajime Takata, mentioned that this is very unlikely as Japan needs to keep interest rates ultra-low for healthy economic growth.

In conclusion, a weaker yen can be viewed as an opportunity as global inflation normalises. However, financial markets, stock prices, and currency exchanges are influenced by a myriad of economic factors and are subject to the policies of governments and central banks. The effects of a sliding yen would continue as a dynamic tale with no shortage of twists and turns.