At more than 145 yen per dollar, the Japanese yen has slipped to a 24-year low. After the Bank of Japan (BoJ) signalled further depreciation would be tolerated, Finance Minister Shunichi Suzuki stated that ‘excessive, disorderly currency moves could negatively impact the economy and financial conditions’. The massive foreign exchange intervention that followed to strengthen yen could not reverse the depreciation pressure. That may signal that Japan’s post-bubble crisis management has reached its limits.
The roots of the current policy dilemma go back to the bursting of the Japanese bubble economy in December 1989 — an event triggered by the sharp interest rate cuts of the BoJ in response to the post-Plaza yen appreciation.
Since the early 1990s, Japanese policymakers have been trying to cure the persistent post-bubble recession through a long series of public expenditure programs backed by government bond purchases by the BoJ. This policy accelerated in 2013 under former prime minister Shinzo Abe with Abenomics. The Abenomics policy brought general government debt to more than 260 per cent of GDP and has inflated the BoJ’s balance sheet.
This ultra-expansionary monetary policy was for a long time accompanied by low inflation because the extensive government bond purchases of the BoJ allowed the Japanese government to subsidise corporations, goods and services. Ever-declining financing costs for enterprises, as well as subsidies for food, transportation and education, prevented the price level from rising. The generous provision of funds created zombie enterprises, which increased their capital instead of investing in higher efficiency.
The resulting low inflation and low productivity gains helped narrow nominal wage increases. As the BoJ kept long-term interest rates substantially below the United States, persistent net capital outflows finan-ced current account surpluses.
The resulting build-up of large dollar-denominated net foreign assets (equivalent to US$3.6 trillion) implied persistent appreciation expectations on the yen since foreign assets can be reconverted into yen at any time. Because the United S-tates followed a similar mo-netary expansion, the yen did not come under sustai-ned depreciation pressure.
The situation has changed because the US Federal Reserve is now decisively increasing interest rates. With consumer price inflation reaching 8.3 per cent in August 2022, inflation has become a severe political problem for US President Joe Biden.
Rising discontent about the instability of the US dollar as the leading international currency has led to attempts to de-dollarise foreign assets in large countries such as China and Russia. More and more people in developing countries have tended to hold bitcoin instead of dollars.
Like at the end of the high-inflation period of the 1970s, the exorbitant privilege of the United States to raise foreign debt in its own currency is at risk. This heralds the end of Japan’s p-ost-bubble model of macroeconomic stabilisation, brought to a peak in the for-m of Abenomics and plan-ned to continue under Japa-nese Prime Minister Fumio Kishida’s New Capitalism.
If the BoJ keeps interest rates low while the US Fe-deral Reserve keeps raising rates, the yen will continue to depreciate. Prices for im-ported goods — particularly raw materials, fuel and food — will rise, further eroding purchasing power.
If trade unions demand higher wages, the past wage austerity could be followed by a price-wage spiral. If the government continues to hide inflation through subsidies, the vicious circle of rising government debt and monetary expansion will accelerate, further eroding the yen’s credibility. These fears are more credible now that important trading partners such as South Korea have followed Washington’s interest rate path.
If the BoJ increases interest rates to contain yen depreciation, the government’s interest burden will rise. During three decades of rising government debt, the BoJ kept government interest rate payments low by depressing the interest rate of government bonds close to zero.
Interest on 10-year US government bonds has risen from 1.6 per cent to 3.8 per cent in 2022, while the BoJ has kept interest on 10-year Japanese government bonds at 0.24 per cent. With almost double Washington’s general government debt, a sovereign debt crisis would loom if rates rise.
Unless the US fed does not unexpectedly reverse its monetary tightening, Japan is trapped. To escape, gradual interest rate increases and substantial cuts in government expenditure would have to be implemented. That would reanimate Japan’s zombie enterprises and stimulate growth. The reforms would be facilitated by the fact that the corporations are sitting on large piles of equity. The repatriation of foreign assets could help to boost domestic investment.
Despite this positive outlook, the necessary reforms look like political suicide. Japan may first have to go through a longer period of inflation to melt down the immense burden of government debt before it can implement the necessary reforms.