07 Oct The Rise and fall of the Japanese YenDuring the fi
The Rise and fall of the Japanese YenDuring the first half of the 2000s, the Japanese yen was relatively weak against the U.S. dollar. This was a boon for Japan’s export-led economy. On January 1, 2008, ittook 122 yen to buy one U.S. dollar. For the next four years, the yen strengthened relentlessly against the dol- lar, hitting an all-time record high of ¥75.31 to the dollaron October 31, 2011. The reasons for the rise of the yen were complex and had little to do with the strength of the Japanese economy because there has been very little of that in evidence.The weakness of the yen during the early to mid- 2000s was due to the so-called carry trade. This financial strategy involved borrowing in Japanese yen, where in- terest rates were close to zero, and investing the loans in higher yielding assets, typically U.S. Treasury bills, which carried interest rates 3 to 4 percentage points greater. Investors made profits from the interest rate dif- ferential. At its peak, financial institutions had more than a trillion dollars invested in the carry trade. Because the strategy involved selling borrowed yen to purchase dollar-denominated assets, it drove the value of the yen lower. The interest rate differential existed because the Japanese economy was weak, prices were falling, and the Bank of Japan had been lowering interest rates in an at- tempt to boost growth and get Japan out of a dangerous deflationary cycle.When the global financial crisis hit in 2008 and 2009, the Federal Reserve in the United States responded by injecting liquidity into battered financial markets, effec- tively lowering U.S. interest rates on U.S. Treasury bonds. As these fell, the interest rate differential between Japanese and U.S. assets narrowed sharply, and the carry trade became unprofitable. Financial institutions un- wound their positions, selling dollar-denominated assets and buying yen to pay back their original loans. The in- creased demand drove up the value of the yen.For Japanese exporters, the 40 percent increase in the value of the yen against the dollar (and the euro) between early 2008 and 2012 was a painful experience. A strong yen hurts the price competitiveness of Japanese exports and reduces the value of profits earned overseas when translated back into yen. Take Toyota as an example: In February 2012, the company stated that its profit for the year ending March 31, 2012, would be about ¥200 bil- lion, 51 percent lower than in the prior year. Toyota makes nearly half of the cars it sells globally at its Japa- nese plants, so it has been particularly hard hit by a rise in the value of the yen.In late 2012, things started to change when the pro- business Liberal Democratic Party won national electionsand Shinzo Abe was appointed prime minister. Abe had campaigned on a platform that included taking actions to weaken the value of the yen in order to help Japan’s ex- porters. Even before the election, Japan’s central bank had accelerated purchases of government securities, thereby expanding the money supply, and had agreed to a higher inflation target. Under Abe’s leadership, this policy had explicit government support. One conse- quence of the policy was to reduce the value of the yen against other currencies. Indeed, between October 2012 and December 2013, the yen lost more than 25 percent of its value against the U.S. dollar. The yen was trading at ¥104 to the U.S. dollar in late December 2013. While this helped Japan’s exporters, the policy was criticized by other major industrial nations as unilateral action that came dangerously close to precipitating a currency war.SourcesCase Discussion Questions
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