In 2022, Japan faced significant economic challenges as it spent over $60 billion of its foreign-exchange reserves in a bold attempt to defend the yen—marking its first intervention to bolster the currency in nearly 24 years. Despite these efforts, by the close of the year, the yen weakened further, raising questions about the efficacy of battling market forces.
The yen’s depreciation can largely be attributed to the diverging economic policies and interest rate environments between Japan and the United States. While the Bank of Japan modestly raised its interest rates in February 2022, from a range of minus 0.1% to zero to between zero and 0.1%, American rates soared over five percentage points higher, spurred by a robust economic outlook. This discrepancy has resulted in a marked interest rate gap, with a ten-year Japanese government bond yielding just 0.9%, compared to 4.6% for an equivalent American Treasury bond.
The different perspectives on inflation between the two nations also play a crucial role. Japan has struggled with low inflation and periods of deflation since the asset price collapse in the 1990s. Despite achieving above-target headline annual inflation rates in recent years, there are indications that the inflation pace is decelerating. The Bank of Japan, focusing on achieving its inflation target rather than supporting the yen, has contributed to this economic divergence from the U.S., where inflation concerns continue to delay any potential cuts in interest rates.
Japan’s open capital account makes its currency particularly susceptible to international shifts. The appealing “carry trade,” where investors borrow yen to invest in higher-yielding dollars, exacerbates the yen’s weakness and strengthens the U.S. dollar. While currencies can deviate from fundamental values, it is challenging to determine when this occurs and how to respond appropriately.
Following Japan’s intervention in late 2022, a temporary improvement in the yen’s value occurred as U.S. bond yields declined. However, this was short-lived, and the yen resumed its downward trajectory in 2023. This pattern underscores the limitations of resisting market-adjusted exchange rates, often providing speculators with lucrative opportunities to capitalize on predictable policy responses.
The motivation behind Japan’s interventions—stemming from political calculations and national pride—highlights the complexities of economic management in a global context. A depreciating yen, while boosting exports, significantly increases the cost of imports, notably energy, affecting the domestic economy and voter sentiment. Despite possessing substantial foreign-exchange reserves, Japan’s continued expenditure to combat market trends raises concerns about the strategic use of its financial resources.
As Japan persists with these costly interventions, it is essential to reassess the long-term impact on its economy and explore more sustainable fiscal and monetary policies. Engaging with global economic trends rather than opposing them could offer a more stable and prosperous future for Japan’s economy.
