Chief economist urges Japan to take advantage of yen weakness now

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A Japanese economic term has been a thorn in my side recently, and that is “bad yen depreciation”. The use of value-judgmental terms to describe yen weakness should be avoided, especially when discussing policy.

Exchange rates should be determined by market mechanisms

To be fair, it’s not hard to see why people are tempted to call it “bad yen depreciation.” A weak yen means a loss of purchasing power for the Japanese people, which has caused great hardship in the livelihoods of many people. And given the widening interest rate gap between Japan and the United States, the trend is not likely to stop anytime soon.

That said, it would be absurd to demand that the Bank of Japan (BOJ) raise interest rates immediately. The main objective of current monetary policy is to end deflation. Although the price index remained above the BOJ’s 2% target, it is highly doubtful that this is a lasting trend that can lead to wage increases.

Bank of Japan Governor Haruhiko Kuroda holds a news conference on September 26 in Osaka city. (Photo swimming pool)

The effectiveness of BOJ Governor Haruhiko Kuroda’s monetary easing, now in its 10th year, will have to be examined again. In any case, changing monetary policy in the name of short-term exchange rates is out of the question.

Japanese financial authorities intervened in the exchange rate market on September 22. But that is no panacea either. Exchange rates should be determined solely by market mechanisms. Intervention can stop sudden moves, but it should not be considered powerful enough to move the entire market.

Weak yen chart
An exchange monitor showing that the yen has appreciated strongly following government intervention in foreign exchange. (Higashi Shimbashi, Tokyo, September 22. ©Kyodo)

Yen weakness is a tailwind for some, a heavy burden for others

To begin with, market mechanisms are always followed by tears and laughter. The weak yen is a tailwind for the export industry. At the same time, it is a heavy burden for the import industry. While some are troubled by the rising price of imported wine, this represents an opportunity for domestic wine producers. The key question is how to take advantage of yen weakness.

We can say that the current exchange rate is 70% due to the strength of the dollar and 30% due to the weakness of the yen. The United States drastically tightened its monetary policy by raising the interest rate by 0.75% for the third consecutive time. This caused the dollar to appreciate against almost all currencies. Although it was aimed at curbing runaway inflation in the United States, which climbed 8% year-on-year, it will undoubtedly slow the global economy. The dollar’s isolated rise will eventually peak.

Exchange rates are determined by the balance of power between currencies. There is no fair value or “theoretical value”, and sometimes it can get out of hand. For example, something could trigger a selloff in a particular currency. Investor sentiment becomes hysterical when the market is unstable, as it is now, and could even lead to bullying-like behavior.

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Reduce yen sales based on actual demand

When Britain’s Liz Truss administration announced its tax plan last month, it was hit by a strong sell-off in UK bonds and a weakening pound. Faced with this kind of “harassment”, the first thing to do is to pretend that it does not hurt.

Liz Truss makes a statement outside 10 Downing Street where she announced her resignation as Prime Minister, in London, Thursday, Oct. 20, 2022. (Stefan Rousseau/PA via AP)

The Truss administration quickly withdrew the tax cut plan. But I wonder what would have happened if he had reacted with fierce resistance? Fighting a runaway market should always be avoided.

What policies, then, should the Japanese government adopt? While stemming the widening interest rate differential between the yen and the dollar is not easy, it is essential to steadily reduce demand-driven yen selling.

The trade deficit in August reached 2.8 trillion yen (about $19.7 billion) in a single month. Indeed, the prices of fossil fuels such as crude oil, liquefied natural gas (LNG) and coal have doubled or tripled compared to the previous year. The larger the trade deficit, the greater the willingness to sell yen and buy dollars.

So what steps can be taken to improve the balance of payments? An obvious first step is to increase exports. Thanks in part to the weakness of the yen, Japanese exports are currently strong, reaching 8 trillion yen (about $55 billion) per month. In terms of products, exports of steel manufacturing equipment and semiconductors are growing. However, auto exports need a bit more work.

Restart nuclear power plants now

The problem is that imports are growing at a faster rate than exports. It follows that the second step is to reduce the use of fossil fuels. Using more renewable energy is also in line with the medium to long term decarbonisation objective.

In addition, Japan must urgently restart its nuclear power plants. Fully operated nuclear power plants would significantly reduce Japan’s LNG consumption. In turn, the LNG could then be sent to countries in Europe that are rushing to “de-Russianize” their energy sources.

Mihama Nuclear Power Plant

Hopes are high for an increase in the number of foreign visitors following the easing of border restrictions in October. Before the COVID-19 pandemic completely halted inbound tourism, the number of overseas visitors peaked at 31.88 million in 2019. Japan’s travel balance for that year was a surplus of 2.7 trillion yen (about $18.5).

Boosting consumer spending through increased inbound travel would be the most obvious way to take advantage of a weaker yen. A vacation in Japan at an exchange rate of 140 yen to the dollar is a bargain, so to speak. Tourists who take advantage of cheap vacations in Japan could become regular visitors, helping to recover the tourism industry from the ravages of the pandemic.

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There is no point in complaining about a “bad depreciation of the yen”. Discussions should instead turn to how Japan can seize the moment to take advantage of yen weakness.

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(Read the article in Japanese on this link.)

Author: Tatsuhiko Yoshizaki

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