Can Japan save the yen?

Today we’re looking at one of Japan’s historic foes. It’s big, destructive, and the authorities are unable to stop its advance. We’re talking of course, about Godzilla the weak yen.

How weak? Depends which aperture you use, but we’re talking 3.6% off vs the dollar in six months 🥱, 11% down in a year 🤔, or 35% down in three years 😮. If you want to use Japan’s real effective exchange rate (REER), Japan’s yen has halved in 40 years 😵.

Even in nominal terms, the yen just hit its lowest level against the USD since 1986, which is back when humanity was still blowing on Nintendo cartridges to make Zelda work.

And that’s despite the Bank of Japan burning a cool ~$70B in market intervention this year alone, all in an attempt to tap the yen’s brakes.

So… what’s going on?

Just like Godzilla, the weak yen’s origin story has multiple layers, including three cyclical.

The first reflects the gap between lower interest rates in Japan and higher rates in the US. Like moths to a flame, foreign capital follows those sweet sweet returns.

The second cyclical driver is around higher oil prices (90% of Japan’s imports are via the Middle East), with Japan having to spend more USD (sell more yen) to quench its thirst. 

The third is a little paradoxical: sure, Japan’s recent stock rally has lured foreign investors, but many actually hedge their currency risk by selling yen forward, weakening it further.

There are also, however, three deeper, interrelated structural drivers behind the weak yen.

The first is the gradual loss of Japan’s manufacturing edge either to offshoring or rivals like China — so a weak yen no longer supercharges Japan’s exports the same way.

The second structural driver is Japan’s demographic drag, with a shrinking and ageing workforce capping long-term growth and reducing the international appeal of yen assets.

And the third is Japan’s massive fiscal overhang, occasionally rattling investors around the longer-term sustainability of Tokyo’s debt.

So… what’s this all mean for Japan?

Sure, it creates all kinds of winners, like anyone now “exporting” a lower-cost Japanese experience to every 30-year-old Westerner suffering early-onset mid-life crisis.

It also creates all kinds of losers, like that poor ol’ Takamatsu retiree starting to feel like their trip to the grocery store is some kind of financial Takeshi’s Castle.

But we’re also interested in the complications this all creates for Tokyo:

First, the Bank of Japan gets left walking a tight-rope of keeping rates high enough to stabilise the yen, but without torpedoing growth or spiking Tokyo’s interest costs.

Second, Tokyo knows it needs to defuse Japan’s demographic time bomb, and it’s taken baby steps to (say) encourage more women into the workforce, raise the retirement age, and even — whisper it — invite more immigrants. But that all risks clashing head-on with some of Japan’s deeply conservative instincts.

And third, Japan’s fiscal overhang makes it all harder — longer-term competitiveness would mean spending more on R&D, manufacturing subsidies, and tech investment, precisely the kinds of outlays that increasingly clash with Tokyo’s existing debt burden, and force (or delay) uncomfortable choices on taxes and entitlements.

For now, Takaichi’s play seems clearer — her new $2.3T package investing in tech and strategic sectors is an attempt to escape Japan’s lower-growth trap longer term. But in the meantime, it means even more borrowing, and even more yen pain. Godzilla stumbles on.

Sound even smarter:

• The Bank of Japan has recently stopped telegraphing its yen moves, instead using ambush tactics to neuter the speculators and maximise the post-intervention sugar hit.