The Japanese yen is once again flirting at 150 to the U.S. dollar, a year after a massive solo intervention in the foreign exchange market to stem the yen’s precipitous fall by the Bank of Japan on behalf of the ministry of finance, without the U.S. Treasury’s participation. The October 2022 intervention was meant to punish speculators once and for all, teaching them a lesson on the costs associated with their positions. Well, they probably learned a lesson that their bet couldn’t always be one way. At the same time, many of them must have revisited their strategy and confirmed its long-term validity. So they held onto the strategy, driving the yen back to where it was last October.
Japanese Finance Minister Shunichi Suzuki is making statements on a potential measure to stem the yen’s fall. He is not, however, taken seriously since his competence is always questioned by market participants. A year ago, it was the yen’s unilateral fall that drove the greenback to 150. This time around, the mighty U.S. dollar is displaying its resilience against all the currencies, hard ones or else. The yield on a 10-year Treasury note is at its highest since the eve of the global financial crisis of 2007–09, and is rising toward 5 percent. The most anticipated recession in history, not surprisingly, has failed to take place in 2023. Resilience in the United States beats the economies in the rest of the world, be they the European Union, the United Kingdom, Japan, and, of course, China.
The yen is currently trading at its lowest in terms of real effective exchange rate (REER), which considers inflation, ever since it went free-float in February 1973. For the next 20 years, the yen soared relentlessly, in response to the rise of Japan’s economic might, reaching its peak in the spring of 1995. (On a personal note, I had a vacation at Walt Disney World in Orlando, Florida, that spring, in a week that the yen broke 100 against the dollar for the first time ever. The sharp upswing made me feel that everything in the United States was offered almost free. By the time the vacation was over, the yen was in the low 90s. Right after the vacation, I was at an emerging market conference, by Lehman Brothers, at Four Seasons Hotel Tokyo. There were some participants from the United States, and I overheard them saying, “Everything is so expensive here!” In late spring, the yen broke the 80 barrier for a moment, and then stopped, due to concerted interventions by the U.S. and Japanese authorities.)
The mid-1990s’ surge of the Japanese yen was driven by Corporate Japan’s repatriation of cash that was parked in their overseas subsidiaries. Following the burst of an economic bubble at the outset of the decade and a deep economic slump that followed it, Japanese companies were pressed to reconstruct balance sheets, and brought back their cash to the headquarters for this purpose. The move caused a wave of inflows of money to Japan. That marked the height of the yen in terms of REER. Over a decade later, in the aftermath of the 2007–09 financial crisis, the yen’s nominal value against the greenback surpassed the level witnessed in the spring of 1995, though not by much, and stayed there for a couple of years, unlike in 1995. The yen was bought on higher real interest rates than others. Despite the Bank of Japan’s (BOJ) zero interest rate policy, the yen’s real interest rates were perceived as attractive because of deflation. The BOJ’s monetary policy wasn’t accommodative enough, the markets thought. The upward pressure in 2009–12 nonetheless was less severe than it was in 1995 in terms of REER.
The return of Shinzo Abe as prime minister at the end of 2012 brought a sea change to the foreign exchange market. In order to relieve the Japanese economy of persisting deflationary pressure, Prime Minister Abe advocated aggressive monetary easing, which had already been implemented by U.S. Federal Reserve Bank Chairman Ben Bernanke in the post-crisis U.S. economy. With a reason to buy the yen having been removed, the Japanese currency fell like a stone from overvalued levels.
With its overvaluation quickly corrected, the yen was rather inexpensive by the end of the 2010s. Low prices brought in a wave of foreign visitors to Japan. Corporate Japan, however, chose not to move. Corporate leaders didn’t show much interest in bringing back factories that they built overseas in response to persistent trade frictions in the past as well as high costs of making things on the Japanese soil. Many of them became multinational in a true sense, with a network of subsidiaries and factories around the world rather than exporting out of factories in Japan.
In contrast to the 1990s, Corporate Japan no longer brings back profits parked in their overseas subsidiaries. They would rather use that cash to expand business on the soil of the United States, Europe, or wherever they operate. A weaker yen, therefore, no longer contributes to build trade surpluses or reduce deficits; rather, it hurts the trade account due to higher import costs, notably that of crude oil.
A decade of falling yen is pushing ever risk-averse Japanese households to the direction of some risk-taking. At the end of June 2023, cash and its equivalents still represented 52.5 percent of ¥2,114 trillion held by the household sector. They were nonetheless less risk-averse than they were six months earlier when they had 54.5 percent in cash. During the six-month period, their exposure to stocks and mutual funds rose from 13.3 percent to 15.7 percent. Foreign currency assets rose to 3.5 percent from 3.2 percent. After decades of extreme worries over potential foreign exchange losses, they are warming up to accept non-Japanese yen assets in their portfolios. Japan’s current account surplus is approximately 2 percent of GDP, or ¥11 trillion, which is mere 0.5 percent of household sector financial assets. Households’ selection of assets far outweighs what Corporate Japan does, and they are becoming more open to foreign assets.
So, is there anyone interested in buying the Japanese yen? Perhaps not. If and when the yen recovers from today’s oversold levels, at least to a certain extent, it might be on the REER front, not nominal value. Based on the current fundamentals, the yen does not seem capable of appreciating beyond 125 to the dollar. The yen could, however, rise more distinctly in terms of the REER in this new environment where prices in Japan are rising at long last. Persistent inflation erodes a currency’s real value. If the yen hovers around where it has been for some time, instead of falling further, that still means depreciation through erosion of its real value. This might be what’s in the pipeline.
