In recent times, the Japanese yen has been experiencing a continuous decline against the US dollar, leading to alarm and concern among economists, traders, and the Japanese populace alikeThe yen has marked four consecutive years of depreciation, and as of December 31, 2024, it is hovering around 156 yen to the dollarThe situation shows little sign of improvement as we step into 2025, with the yen further plummeting to as low as 158 yen in mid-January, subsequent to a speech by Bank of Japan’s Vice Governor, Norihiro Kato, addressing the future of Japan's economic policyThis prolonged slump raises a fundamental question: why has the yen been declining relentlessly, and why have the Bank of Japan's interventions been largely ineffective?

At the heart of the yen's troubles lie two primary factorsFirstly, Japan's economic recovery has lagged compared to other advanced economies, particularly the US and Europe, exiting pandemic restrictions more robustly

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For instance, Japan's GDP in 2021 was still trailing behind its 2019 levelsAs an island nation reliant heavily on imports—90% of its energy and 40% of its food—Japan is particularly vulnerable to external shocksFollowing conflicts that have escalated globally, the prices of energy and food soared, further exacerbating Japan's import costsIn September 2022, the core consumer price index surged by 3%, the highest in eight years, and inflation persisted for 13 months, with gas and electricity rates spiking over 20%. The mounting pressure on both businesses and households complicates the landscape further.

Meanwhile, in response to inflationary trends, the US has initiated a series of interest rate hikes, while Japan is left with no choice but to retain its loose monetary policy to catalyze economic recoveryAs a result, interest rate differentials between the two nations have widened, propelling traders to sell yen in favor of the higher-yielding dollar, thereby directly precipitating the yen's decline

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This external juxtaposition of economic recovery strategies amplifies the yen's growing weakness on the global stage.

Over the past two decades, the world has witnessed rampant money printing, particularly after the global financial crisis of 2008. While many countries saw marked increases in inflation as a result, Japan has inexplicably remained in a persistent deflationary environment, with stable price levels that contrast sharply with other economies that experienced a surge in living costs due to similar monetary tacticsThis leads to an unusual yet significant observation: despite the considerable amounts of yen printed, why has Japan been unable to stimulate its domestic economy or produce inflationary pressure effectively?

To dissect this phenomenon, let’s resort to a simple economic principle—the equation that governs pricing is essentially based on the relationship between the supply of money (currency in circulation) and the quantity of goods available in the economy

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In Japan, demographic shifts and stagnant population growth mean that demand for goods has remained fairly constantIf we consider the money supply in circulation, we notice limited substantial changes in response to the massive fiscal policy shiftsThis inconsistency raises the intriguing question: where has the vast amount of yen produced all these years gone?

The pivotal reality to acknowledge here is the notion of Japan's "lost three decades," paradoxically matched by extraordinary gains overseasThis phenomenon is predominantly characterized by a surge in private currency trading, where Japanese households accounted for a staggering 63% of the total funds allocated to foreign exchange trading, dwarfing contributions from financial institutionsJapan now boasts a commanding position, controlling an estimated 35% to 40% of global retail foreign exchange trading.

In pursuit of profits within a low or even negative interest rate environment, many Japanese investors have resorted to borrowing yen, only to invest proceeds in higher-yielding currencies like the dollar

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These investments are predicated on the principle of currency appreciation, where investors hope to benefit by exchanging their capital back to yen at a more favorable rate laterIt is a dance of currency with profit motives exacerbating the volatility, which is a familiar labyrinthine economic maneuver.

This speculative behavior manifests itself further in a variety of investment strategiesSince the 1990s, Japan's stock market has been gripped by a lengthy bear market, prompting domestic investors to seek refuge in foreign assets as a hedge against the stagnation of local capitalFrom 1996 to 2022, Japan's foreign investments escalated an astounding eightfoldIn fact, Japan has been recognized as the world's largest net creditor nation for 32 consecutive years, echoing the sentiment that Japan has ‘created another Japan abroad’ through savvy overseas investments.

Data from Japan's Ministry of Finance demonstrates that by the end of 2023, the nation holds a GDP of approximately 591.5 trillion yen, while its net foreign assets soared to 471.306 trillion yen, marking a year-on-year increase of 12.2%. The reason behind this striking growth lies in the yen’s enduring depreciation—assets acquired abroad are continuously gaining worth when calculated back into depreciated yen, thereby bolstering Japan's position in international markets.

Consequently, amid a shift from trade surplus to trade deficit, this tactical maneuvering has not just strengthened Japan's economic foundation but has also fostered resilience during its prolonged deflationary episode

The yen's status as a "safe-haven currency" is inherently tied to this unique economic interplay, attracting both domestic and international investors as they seek to capitalize on market fluctuations.

Foreign investors are no exception; upon witnessing attractive investment opportunities elsewhere, they often resort to borrowing in yen to enhance their leverage against currencies like the dollar and euroWhen major financial disruptions occur, these investors typically reverse course, converting their revenues back to yenThis creates a cyclical effect on the currency—when capital floods in, the yen appreciates sharply; when it exits, the currency suffers from rapid depreciation.

Historical precedence illustrates that during crises, Japanese officials undertook drastic measures to defend the yen's valueIn April 1998, Japan spent $21 billion—10% of its reserves—propping up the yen without much impact

In contrast, in June of the same year, bilateral support from the U.Sallowed Japan to stabilize with only $2.5 billionPast interventions raise skepticism regarding Japan’s capacity to unilaterally influence the currency markets, with experts asserting that uncoordinated interventions often lead to temporary spikes in the yen's value without addressing its fundamental downward trajectory.

The conundrum deepens when the Japanese authorities express contradictory policy approaches—while they intervene in currency markets, they remain steadfast in maintaining low interest ratesThis policy dichotomy reflects Japan's predicament: abstaining from increasing rates will likely lead to more severe depreciation of the yen, while raising rates could worsen the debt burden on households, corporations, and the government, creating further economic disarray.

Ultimately, the ongoing decline of the yen is emblematic of broader disparities between Japanese and American economic strategies

For genuine stabilization of the yen, Japan has two pathways: to either wait for the U.Sto suspend its rate hikes or to decisively raise its own ratesPresently, both alternatives appear improbable—U.Smonetary policy is heavily focused on combating inflation, while Japan’s leadership, including the Prime Minister and the Finance Minister, have suggested that aggressive action is necessaryYet, the Bank of Japan Governor has made it clear that an increase is not suitable at the moment; even minor adjustments may do little to correct the declining trend, potentially stifling recovery efforts.

Before any policy turns, interventions in the foreign exchange markets remain one of Japan's few tactical optionsHowever, unilateral action poses significant limitations and might endanger Japan's foreign reserves, which have been dwindling from $1.4 trillion at the end of 2021 to about $1.24 trillion by late September 2022. The immediate funds available for forex intervention drop to a critical 140 billion dollars, which won't withstand extensive market operations