For the past few months, the yen has been collapsing in slow motion. Sorry, did I say months? I meant years. Just a few years ago, before COVID, one U.S. dollar got me about ¥105. This morning? A single dollar gets you around ¥145. That’s a 50% devaluation in just a few years. So what’s going on?[1]
Here’s a quick and plain-English explainer for those of you who want to understand the big picture without slogging through academic papers or cryptic financial jargon.
Interest rates. This is the simple heart of the problem.
Let’s start with the most basic lever: interest rates. The U.S. Federal Reserve has jacked up rates to fight inflation. The Bank of Japan has done… almost nothing.
In 2022, the Fed’s rate was basically zero. As of today, it's 4.5%. Meanwhile, Japan’s interest rate just moved above zero this year — for the first time since 2016.
This means investors around the world would rather park their money in the U.S., where they get a higher return. To do that, they have to sell yen and buy dollars, which drives the dollar up and the yen down.
This would seem bad on the surface, so why does Japan do it? You need to understand that Japan doesn’t want a strong yen. Japan’s been fine with a slightly weak yen for decades. It helps exports. In my footnote above I mentioned that twenty years ago the yen was quite a bit higher than the dollar — and although the Japanese people enjoyed the imbalance, Japanese industry hated it and pressured the government to get the yen lower as soon as possible. A slightly weak yen is good for Japan.
A Toyota made in Japan becomes cheaper for Americans to buy, for example, which is good for Toyota. This kind of trade imbalance benefitted Japan enormously in the past — when it was ¥360 to the dollar — and helped fuel the so-called "post-war economic miracle", and it still benefits Japan today.
The Japanese economy, however, has changed a lot from the post-war days and now if the yen is too weak, things start to break.
- Imports like oil, gas, and food become expensive
- Japanese consumers start feeling poor
- Wage increases don’t keep up, so real incomes fall
- Japanese companies that rely on imports (many do) take a hit
- Japanese investors increasingly put their money overseas — adding more pressure on the yen.
The central bank could raise interest rates to slow the decline, but Japan has one big problem: debt. Over 260% of its GDP is government debt. Raising rates means paying more interest on all that — something Japan simply can’t afford.
Intervention? Too little, too slow
The Japanese government has occasionally stepped in to buy yen and sell dollars, trying to slow the collapse. But it’s like trying to hold back a river with a broom. If the underlying interest rate policy doesn’t change, the market just waits for the broom to break.
So the yen keeps falling. And I watch the buying power of my Japanese savings account fall.
For people here, this is bad, especially for people who think in foreign currency terms. But for tourists, this is a boon: A vacation in Tokyo is suddenly half-price. There is some positive here for Japan, as tourism does bring a lot of money in. Many places are taking advantage of this by charging tourists more (on the other hand, this has led to some hard feelings when the tourists in question can read Japanese and see that the price for locals is much lower).
History tells us that currency pegs and extremes eventually snap back. But history also tells us that it can take a lot longer than we think. Right now, Japan is betting that slow and steady will win the race. But the market is betting against it — and so far, the market is winning.
And — as always — this is a great reminder of why we might consider buying precious metals — or at least investing in some mining ETFs or stocks as I suggested in a post a few weeks ago. Currencies can collapse, and they can do so faster than anyone expects.
Looking at the long view, it's even worse. Two decades ago, the yen was quite high against the dollar. At that time a dollar would only get you about 80 cents. Good times! I was able to make quite a bit converting my paycheck (which was in yen) to dollars. ↩
