Wealth

Decoding the Devaluation: Implications and Challenges of the Yen’s Downward Spiral

In the realm of global economics, the recent devaluation of the Japanese Yen has sparked significant concerns and implications for Japan’s economic landscape. With the Yen hitting a low of 156 to the US Dollar, the country faces a pivotal moment characterized by challenges and uncertainties.

The devaluation of the Yen stems primarily from the substantial interest rate differentials between Japan and the United States. This discrepancy has triggered a range of economic issues within Japan, including input-driven inflation, declining real wages, reduced household consumption, and impacts on Japanese companies’ global strategic investments.

In response to the Yen devaluation, the Japanese government and central bank have implemented various measures, such as the cancellation of negative interest rate policies and increased purchases of government bonds. Despite these efforts, the devaluation persists, highlighting concerns over the potential return to long-term deflation, the efficacy of financial operations, and the impact on small and medium-sized enterprises.

Additionally, Japan faces the looming challenge of a significant debt burden, raising fears of a potential “super bubble” burst and the risks associated with interest rate hikes as a double-edged sword.

As the Yen continues its downward trend, Japan navigates a critical juncture in its economic trajectory, balancing the need for stability with the urgency of addressing the underlying factors driving the devaluation. The implications of the Yen devaluation extend beyond currency markets, shaping the broader economic landscape and prompting a reevaluation of policy measures and strategies to mitigate risks and foster sustainable growth.

On May 14, the Japanese yen exchange rate depreciated again to 1 US dollar = 156 yen, less than two weeks after the last exchange rate intervention. But as U.S. Treasury Secretary Yellen pointed out in a recent interview with Bloomberg, “Intervention is not always effective when the basic policies remain unchanged.” Because the huge interest rate difference between Japan and the United States is the main reason for this round of yen depreciation.

  ‘Bad yen depreciation’

Two years ago, on April 15, 2022, Japanese Finance Minister Shunichi Suzuki endorsed the “bad devaluation of the yen” in an interview with reporters, which means that the Japanese government clearly admitted that the depreciation of the yen has done more harm than good. On that day The Japanese yen exchange rate has rapidly depreciated from 1 US dollar = 115 yen in early March to 126 yen. During this period, although the Japanese Ministry of Finance conducted foreign exchange intervention three times from September to October of the same year, the yen continued to fall, and even fell below 160 yen in April this year. In the past two years or so, the Japanese yen exchange rate has depreciated by as much as 35%. The sharp depreciation of the exchange rate has had a great impact on the Japanese economy.

First, it caused serious imported inflation. According to a survey by Imperial Data Bank, 195 major food manufacturers in Japan raised the prices of 417 items in May, with an average increase rate of 31%, setting a single-month record since 2022. This was mainly due to rising raw material imports and logistics costs. Caused by.

Second, it also leads to a continued decline in real wage income. Survey statistics released by the Ministry of Health, Labor and Welfare show that per capita wages in March 2024 actually decreased by 2.5% year-on-year in the same month of the previous year. This has been negative growth for 24 consecutive months. It is expected that the real wages to be announced in 2023 will also show negative growth.

Third, actual household consumption expenditure has declined, which has become the main reason for sluggish domestic demand. A survey released by the Ministry of Internal Affairs and Communications shows that the average monthly household expenditure in Japan in 2023 is 294,000 yen, which is still lower than the level in 2019. From the perspective of constituent items, ten items related to food and housing all declined, of which food consumption dropped by 1.9% year-on-year.

In addition, the sharp depreciation of the yen has also affected the strategic investments of Japanese companies around the world. In 2023, the number of mergers and acquisitions of overseas companies by Japanese companies was 661, a significant decrease from the 826 cases in 2019. One of the important reasons is the rapid depreciation of the yen, which has weakened the capital power of Japanese companies. Recently, Mitsui Lines President Tsuyoshi Hashimoto pointed out that excessive depreciation of the yen has made mergers and acquisitions of growth companies more difficult.

Of course, the depreciation of the yen also has a positive side in some areas. The profits of export companies represented by automobiles and machinery have been significantly pushed up. For example, Toyota Motor’s operating profit in 2023 exceeded 5 trillion yen, a record. In addition, the devaluation of the yen has also attracted a large number of foreign tourists to travel to Japan, and related companies have also enjoyed dividends, such as airlines, related hotels and railway transportation companies.

  Reasons why we dare not “prescribe the right medicine”

On March 19, the Bank of Japan’s monetary policy meeting decided to lift the negative interest rate policy and raise the policy interest rate from -0.1% to around 0-0.1%. At the same time, it was decided to scrap yield curve controls designed to hold down long-term interest rates and to halt purchases of risk assets such as exchange-traded funds. The “different-dimensional” financial easing policy originally planned for a two-year cycle has finally come to an end after 11 years of implementation. However, at the press conference, Governor Ueda of the Central Bank still stated that “it will maintain a loose monetary environment” and announced that it will maintain a monthly purchase of long-term government bonds of 6 trillion yen.

It must be emphasized that Japan’s “exiting the easing policy” was carried out against the background of the sharp depreciation of the yen. But in the face of the still wide disparity in interest rates between Japan and the United States, the Bank of Japan remains indifferent. The monetary policy meeting on April 26 decided to continue to maintain the current policy. Governor Ueda reiterated that “it has not yet had a big impact on the trend price increase rate.” It was not until May that he changed his tune and admitted that “the depreciation of the yen will easily affect prices.” On May 13, the central bank announced a routine treasury bond purchase operation and announced a reduction of 50 billion yen in the purchase of treasury bonds “more than five years and less than ten years”. In other words, in the policy toolbox, raising interest rates is still not the best option for Japan. So, why has Japan been slow to take the right medicine when faced with the huge pressure of exchange rate depreciation?

First, Japan is very worried that the economy will return to a long-term deflationary state. After the collapse of Japan’s bubble economy in the 1990s, Japan fell into a long-term deflation due to insufficient demand and a declining birthrate and aging population. According to data from the International Monetary Fund, Japan’s consumer price index (CPI) increased by 1.09 times between 1992 and 2022. In sharp contrast, the United States, the United Kingdom, and Italy have almost doubled, while Canada, Germany and France also exceeded 1.6 times. In January 2013, the Japanese government and the central bank signed a joint statement to “get rid of deflation as soon as possible and achieve sustained economic growth” and set an inflation target of 2%.

Secondly, we must ensure effective financial operations. The long-term debt of Japan’s national and local governments will reach 1,315 trillion yen by the end of this year, accounting for 214% of GDP. The debt level far exceeds that of other developed countries such as the United States and Europe. Even based on the current ultra-low interest rates, the interest repayment costs borne by the Japanese government are still as high as 9.7 trillion yen, accounting for 8.6% of the fiscal budget. According to calculations by the Ministry of Finance, “a 1% increase in interest rates will increase fiscal costs by 8.7 trillion yen.” Looking at fiscal revenue, the scale of government bond issuance this year will reach 35.4 trillion yen, accounting for 31.5%. Obviously, if interest rates are raised, it may be the “last straw” that breaks Japan’s finances.

Third, try to avoid a wave of bankruptcies among small and medium-sized enterprises. For a long time, the Japanese government and central bank have relied on fiscal stimulus measures and monetary easing policies to promote economic growth. This has deprived the market of effective competition for survival of the fittest, and a large number of “zombie” companies have survived. Statistics show that the number of “zombie” companies that cannot rely on profits from their main business to repay debts has reached 250,000, accounting for more than 18% of the total. If interest rates are raised, these companies will undoubtedly go bankrupt.

In addition, the housing loan balance of the household sector is also a factor to be considered for interest rate hikes. Statistics from the Japan Housing Financial Support Agency show that as of 2022, Japan’s housing loan balance has reached 215.9 trillion yen, twice the size of the bubble economy period (1989). If interest rates are raised, it will undoubtedly increase the cost of borrowers.

  The terrible “super bubble”

As the yen continues to depreciate against the US dollar, “harvesting Japan” has also become a buzzword. Compared with foreign tourists coming to Japan to “sweep goods”, what is more concerning is the surge in the number of mergers and acquisitions of Japanese companies by investment funds, reaching 1,230 in 2021 and 1,180 in 2022. Moreover, while global mergers and acquisitions are declining rapidly, Japanese mergers and acquisitions are bucking the trend and rising. For example, Bain Capital acquired Kioxia Semiconductor (2 trillion yen), KKR Group (one of the world’s oldest and most experienced private equity investment institutions) acquired Hitachi Logistics (600 billion yen), and Bain acquired Olin Bass Microscope (400 billion yen) and others have attracted market attention.

In fact, the Japanese government has been struggling to get the economy out of the deflationary predicament for a long time, and has even continued to expand its fiscal scale. At present, what worries the Japanese authorities most is the bursting of the “super bubble”. According to statistics from the Institute of International Finance, as of the end of March this year, the world’s debt balance has climbed to 315 trillion U.S. dollars, accounting for 331% of GDP. It will increase by 15 trillion U.S. dollars in 2023 alone, and 55% of the increase will come from developed countries. Obviously, Japan is in the middle of the world’s super bubble vortex. If interest rates are raised carelessly, it may burst the bubble and bring about devastating disasters.

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