Ichiro Suzuki The Japanese yen is under pressure again halfway through 2023. The yen is falling almost unilaterally. Its precipitous fall in the summer and the autumn of 2022 was more or less in tandem with other major currencies, as the flip side of the U.S. dollar’s rise. The dollar kept rising relentlessly until it was stopped by the Bank of Japan’s solo intervention in the market to sell it (on behalf of the Ministry of Finance) when the greenback hit 150 against the yen. In response to the October 2022 intervention, the yen had changed its direction, rebounding sharply against the dollar toward the end of the year. The foreign exchange market almost unanimously anticipated a recession in the U.S. in 2023 as a result of the Fed’s aggressive tightening. Kazuo Ueda, newly appointed as the next governor of the Bank of Japan, was expected to discontinue an ultra loose monetary policy under the outgoing Governor Kuroda, and scrap the yield curve control (YCC) that fixes the long end of the yield curve. As it turned out half way through 2023, however, the most anticipated recession in history is yet to arrive. Fed chairman Powell reiterates that he is not done yet, suggesting two more rate hikes by the end of the year. The BOJ’s Governor Ueda has turned out to be far less hawkish than had been originally expected. He shows no signs of immediately reversing former Governor Kuroda’s monetary policy that ruled Japan’s financial markets for the last ten years. The foreign exchange market is duly responding to the thinking of two central bank chiefs, letting the yen fall. Interestingly, Japan’s Ministry of Finance says nothing about its currency, unlike a year ago. Last summer, Finance Minister Suzuki was furious at the rapid rate of depreciation of the yen. Shouting “It is falling too fast driven by speculators!” the Finance Minister eventually made a solo intervention, without U.S. participation, in the market (through the BOJ). He is silent this time around. Inflation is behaving better at last. CPI in May was up a more acceptable 3.2%, primarily in response to falling energy prices. Crude oil prices no longer rise in the face of OPEC’s production cuts. Though wages remain under pressure due to labor shortages, the worst of inflationary pressure was already seen. This makes politicians feel somewhat relaxed. However, there may be more to this round of the yen’s depreciation. A quiet capital flight might be in progress. This might have been in place already last summer, and it keeps going on in defiance of an intervention by the Ministry of Finance. Economists have been pointing out that the yen can fall in spite of abundant current account surpluses. The vast majority of surpluses today is earned in the form of income from investments in not only in U.S. Treasury securities but also in Corporate Japan’s overseas subsidiaries. In the old days, profits earned outside Japan were converted into the yen to be repatriated back to headquarters at home. Such conversions were major drivers of the yen’s appreciation. Without repatriation of overseas profits, current account surpluses have ceased to be drivers of a stronger yen. Profits earned by Corporate Japan’s overseas subsidiaries stay there due to lack of investment opportunities in the home market. Management would rather look for M&A opportunities elesewhere, as well as expanding already ongoing operations. Since acquisitions are paid by profits parked outside Japan, weak yen doesn’t keep them from overseas M&As. The BOJ’s governor Ueda has to tread carefully. The Japanese economy today is structurally incapable of accommodating higher interest rates after a decade of ultra loose money. While the economy is in reasonably in good shape at this moment, it is vulnerable to higher interest rates. Large corporations are awash with liquidity with minimum amount of debt after decades of balance sheet reconstruction efforts. In fact, their problem is having too much capital that is detrimental to shareholders. In sharp contrast, however, SMEs are highly indebted and could be crushed by higher interest rates. Some of them are experiencing difficulties in repaying COVID-related emergency interest-free loans. SMEs have long been a weak link in the Japanese economy, since it went into a low growth mode 30 years ago. They constitute a solid political base for the ruling Liberal Democratic Party, and hence can’t be crushed all of a sudden. The infamous yield curve control (YCC) needs to be scrapped at the very least, as Governor Ueda perfectly understands. Nonetheless, higher long-term interest rates, higher than today’s negligible 0.25%, however, has to be delivered with extreme caution in the face of fragility of SMEs. In the meantime, amid Governor Ueda’s dilemma, the yen keeps falling, even if it is already the cheapest in 50 years since last year, in terms of real effective exchange rate. Raising interest rates in order to defend the currency is out of the question for the BOJ. Looking at all these factors, participants in the market are fairly relaxed in selling the yen. The Nikkei, the business daily, had recently said the Japanese yen has entered a phase of structural decline, as opposed to structural rise for decades until about ten years ago, which has always made the Japanese business world scared to death. Spreading of such a view pushes more average men and women to seek returns in foreign assets without fears of foreign exchange losses on top of Corporate Japan.
About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.