Ryoji Musha (Representative of Musha Research Co., Ltd.)
-The weak yen guarantees a dramatic revival of Japan’s manufacturing industry-
● Rampant argument that Japan is no good
The yen has fallen sharply, and the dollar to yen is now 151.6 yen, the weakest level in almost 33 years since 1990. The decline in the real effective exchange rate of the yen (2020 = 100), which indicates the strength of the currency, is even more extreme, reaching 72.4 as of the end of September 2023, compared to 83.6 during the Smithsonian system (1971-1973) when the dollar = 308 yen. However, the stock fell to a historic low of 13%.
The media and economists began to talk about the bad yen depreciation. The Sankei Shimbun reported on Japan’s subsidence, stating, “Japan’s nominal gross domestic product (GDP) in dollar terms is expected to decline from the previous year, falling to fourth place.” (November 11) The Nihon Keizai Shimbun published a self-deprecating article (dated November 14) titled, “The era of a weak yen, with 150 yen to the dollar,” highlighting Japan’s weaknesses that cause the yen to weaken. The yen’s depreciation is interpreted by the argument that the yen depreciates as capital flees from Japan, which has weak growth potential.
However, Japan’s low growth potential is not new. Even during the period of appreciation of the yen since 2010, the yen continued to appreciate even though huge amounts of capital flowed to overseas countries with high growth rates. The argument that the yen is depreciating because Japan is failing does not hold up.
●Yen depreciation that cannot be explained by the interest rate differential hypothesis or current account balance hypothesis
There is also a theory that yen carry trades focused on interest rate differentials are increasing. It is true that interest rates in Europe, such as Germany, which until two years ago had negative interest rates lower than those in Japan, have soared, making the Japanese yen more attractive as a funding currency.
However, carry trades result in significant foreign exchange losses if the yen appreciates. If you borrow $1 when $1 = 150 yen and repay it when the yen is strong, with $1 = 100 yen, you would need $1.50 to pay back 150 yen. At a time when the yen has fallen to 151 yen to the dollar, the first depreciation in 33 years since 1990, are people betting on the yen’s further depreciation? If so, it’s a serious gamble.
In recent weeks, the yen has been depreciating despite the narrowing of the interest rate differential between Japan and the United States. Additionally, the yen is depreciating not only against the US dollar but against almost all other currencies. The yen has depreciated even against the Chinese yuan, which is cutting interest rates, and the Korean won, which is losing its hawkish stance.
●Yen depreciation exceeds the Bank of Japan’s limit
I started seeing comments asking for something to be done about this unexplained depreciation of the yen. If the weak yen is the culprit behind the high prices that are robbing people of real income, then the Bank of Japan will have to turn to monetary tightening.
Ueda Bank of Japan probably took the lead in criticizing the acceptance of a weaker yen. Taking the market by surprise, it pulled off a surprise at the end of July and again at the end of October by re-adjusting the YCC (yield curve control) (allowing long-term interest rates to exceed 1%), but it turned out to be a complete empty shot. Since the foreign exchange market is no longer responding to narrowing interest rate differentials, it may be fair to say that the current depreciation of the yen has exceeded the Bank of Japan’s limit.
Looking at the trends in returns for currency hedged 10-year U.S. government bond investments, when Japanese investors hedge against the yen, the hedging costs significantly exceed the interest rate difference, resulting in negative returns of more than 1% for over a year. I know that there is. Since the second half of 2022, the cost of hedging the Japanese yen against the dollar has increased dramatically, and has remained at a high level of 6% since September. The two, which had previously been closely linked, have now diverged significantly, with a recent gap of 4%. Since hedging costs can be seen as a market view that has been factored in by the market, the Japanese yen has suddenly become more undervalued than the interest rate differential.
●The true nature of the weak yen, which is invisible to market participants, is geopolitics
The outlook for the Japanese yen’s depreciation is currently being formed for reasons that are not related to interest rate differences, business sentiment, trade balance, or capital account. Where does this view of the yen’s weakness come from?
That is nothing but the will of the US authorities. In November, Japan (with the fifth largest trade surplus with the US) was once again removed from the US Treasury’s foreign exchange watch list (China, Germany, Malaysia, Singapore, Taiwan, and Vietnam). The ultra-weak yen is the means by which the hegemonic power, the United States, pursues its national strategy, which has no choice but to relocate high-tech manufacturing industries concentrated in the geopolitically dangerous areas of China, Taiwan, and South Korea to the safety of Japan. I have no choice but to think so. Treasury Secretary Kanda and Treasury Secretary Janet Yellen are in the same line, saying, “The level itself is not the deciding factor, but rather the volatility (rate of change) is the issue.”
●Forex does not project economic reality, but creates economic reality.
Both market participants and economists must reverse the cause and effect relationship regarding exchange rates. We must understand that exchange rates are the cause, not the result, of economic reality.
In Japan, many economists used to argue that “the yen’s purchasing power is increasing due to deflation, so it is natural for the yen to appreciate, and we should accept the reality of the yen’s appreciation.” However, the strong yen robbed Japan of its competitiveness, promoted the outflow of companies, business opportunities, employment, and capital overseas, and hurt Japan’s domestic demand, further exacerbating deflation. The vicious cycle of a strong yen and deflation was broken by Abenomics and Kuroda’s extra-dimensional easing, which sought to achieve reflation by inducing a weaker yen.
We should not forget that exchange rates are one of the most important indicators that determine the future economy. The United States, which desperately wants to revive Japan’s industry, is leading to a weaker yen. While South Korea dramatically strengthened its competitiveness and mowed down Japanese high-tech companies during the course of the remarkable depreciation of the won between 2008 and 2013, the entrenchment of a weaker yen will set the stage for Japan’s dramatic re-emergence.
Japan will re-emerge as a huge manufacturing nation and a service (tourism) nation. This will restore Japan’s strong yen in the long term. Japan should enjoy the good fortune of the current weak yen, and should not put up futile resistance such as encouraging the yen to appreciate.
(Reprinted from Musha Research “Strategy Bulletin No. 344” diary on November 15, 2023)
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