Yen and now

The Japanese currency's volatility is a threat to Asian financial security as its plunge in 2022 has led to almost all Asian currencies depreciating

Since March 2022, the Japanese yen has been on a downward spiral, one of the most severe yen exchange-rate fluctuations in history. The currency's sharp fall has led to a rare yen-buying intervention by the Japanese government, which has helped stem the currency's plunge in the short run. However, higher yen volatility has added more uncertainties to the global markets and the world economy.

According to the Bank of Japan, the central bank of Japan, from the beginning of March to the end of April 2022, the Japanese yen plunged by 12.89 percent against the US dollar, with the dollar-yen exchange rate spiking from 114.92 to 129.81, a much quicker depreciation compared with other Asian currencies. After that, the yen continued its losing streak and the cons of a weaker yen gradually outnumbered the pros, raising government concerns. After the Japanese yen plunged to 145 against the US dollar on Sept 22, 2022, the Japanese government spent around 2.8 trillion yen ($19.3 billion) with a dollar selling and yen buying intervention to prop up the yen, the first such intervention since 1998. The yen started to appreciate against the greenback from November last year, but still shows high volatility.

The collapse of the Silicon Valley Bank and Credit Suisse's management crisis in March 2023 have further raised market concerns over the loss in the face value of Treasury bonds caused by interest rate hikes. Therefore, a short-term yen appreciation took place as global investors fled US assets for other safe havens including yen assets.

Violent swings in yen exchange rates, in particular the sharp falls in 2022, are caused by a number of factors.

In the short term, a widening gap between Japanese and US interest rates has been a main cause of excessive yen exchange-rate fluctuations.

The United States has entered a rate hike cycle since the start of 2022; the likes of the European Central Bank and the Bank of England followed by tightening monetary policy. In contrast, the Bank of Japan maintained its ultra-loose monetary policy (keeping short-term rates negative and long-term rates at about zero), becoming the only outlier among developed economies. The widening interest rate differentials between Japan and the US resulted in massive yen selling and dollar buying and the yen sliding against the dollar. Recently, the Japanese yen is gaining ground on market expectations of slower rate hikes by the US and the EU.

From a medium-term perspective, Japan's domestic monetary policy is a decisive factor for the exchange rate. Shinzo Abe began his second term as prime minister in December 2012, pledging to revive growth with his "Abenomics", an important part of which was large-scale quantitative easing aimed at inducing yen depreciation. From December 2012 to February 2013, the Japanese currency plunged by over 8.4 percent against the dollar. Due to pressures from excessive declines in the yen, the Japanese government decided to adjust its ultra-loose monetary policy — the central bank raised its cap on 10-year government-bond yields, from 0.25 percent to 0.5 percent, in December 2022. The yen rose sharply on the news.

From a long-term perspective, however, structural changes in the Japanese economy are the fundamental reason for yen exchange-rate fluctuations. The strength of a national currency depends on a nation's comprehensive national strength and, in turn, exchange rate fluctuations profoundly affect a nation's economic structure. Japan witnessed an economic miracle after the end of World War II. However, the economy has been mired in sluggish growth for over 30 years after its economic bubble burst. A fast-aging population combined with declining birthrates have undermined its growth potential. Worse still, rising government debt levels, deteriorating fiscal health, industrial outflows and mounting trade deficits have made the yen lose its support. With constantly declining global competitiveness, a weaker yen is bound to become a long-term trend.

The Japanese currency's sharp fall was one of the causes for the 1997 Asian financial crisis. The yen's recent plunge has also had a spillover effect on the financial security in Asia.

To start with, the sliding yen has increased potential financial risks in Asia. Yen exchange-rate fluctuations have increased the risk associated with Japanese government bonds; and yen's depreciation has posed challenges to the stability of Japanese monetary policy. According to estimates by Japan's Ministry of Finance, every 1-percentage-point rise in Japanese government bond yields would incur over $220 billion book loss for the Japanese central bank. In the meantime, the debt ratio of Japanese government bonds stands at 177 percent. Every 1-percentage-point rise in bond yields would boost the Japanese government's principal and interest service expenses by 7 trillion yen. As a result, the Japanese government could be incapable of paying back government debts and financial institutions could reel from the unwinding of yen carry trades, bringing turmoil to the financial markets with the Asian financial markets bearing the brunt. Furthermore, yen exchange-rate fluctuations could cause unusual fluctuations in Asian or even global exchange markets, bond markets and stock markets.

Second, a plunging yen increases the depreciation pressure on other Asian currencies and inflationary pressure on other Asian economies. The Japanese currency's recent sharp falls have undermined the export competitiveness of other Asian countries and regions, and further exacerbated their trade deficits. Asian countries are the biggest export destination for Japanese goods. The economies of Southeast Asian countries are mostly export-driven, and the yen's sharp falls have to a certain degree offset the facilitating effect of their currency depreciation on exports, thus enlarging those countries' trade deficits with Japan.

The yen's plunge has put currencies of other East Asian countries and countries in trade competition with Japan under great depreciation pressures. If their currencies do not depreciate, they will become stronger relative to the yen, thus undermining the competitiveness of their exported goods and dealing a blow to those export-driven economies.

In retrospect, almost all Asian currencies have depreciated markedly in response to the yen's plunge in 2022.The competitive devaluation has, in many cases, led to more imported inflation pressures. Central banks have to increase interest rates to avoid currency depreciation, but the move could further hurt economic growth and raise the risk of stagflation amid sharp slowdown in global growth.

Last, excessive yen exchange rate volatility has an impact on Asian asset management. Violent swings in yen exchange rates prompt investment to flow to other economies — financial resources will get reallocated globally and the global economy might face a new pattern. The IMF has recently lowered the yen's weighting in the Special Drawing Rights currency basket to 7.59 percent, signaling a decline in the currency's international influence and growing pressures on the currency to maintain its global status.

The author is an assistant researcher at the Institute of Northeast Asian Studies, China Institutes of Contemporary International Relations. The author contributed this article to China Watch, a think tank powered by China Daily.

The views do not necessarily reflect those of China Daily.