The Japanese yen has long confused foreign visitors and investors – how can 100 yen be worth less than $1?
If you’re short on time, here’s the quick answer: The yen is worth so little because of purposefully weak monetary policies by the Bank of Japan over the past few decades aimed at boosting exports.
This article will provide a deep dive into the reasons behind the yen’s low value.
In this comprehensive 3000-word guide, we’ll cover the history behind the yen’s valuation, Japan’s export-focused economy, the Bank of Japan’s monetary stimulus policies, the concept of purchasing power parity, how currency valuations are set by forex markets, and what the future may hold for the yen.
Read on to gain a full understanding of the complex economic factors that have shaped the modern-day yen.
Brief History of the Japanese Yen
The Japanese yen, known as JPY, has a fascinating history that spans several decades.
Understanding its evolution can help shed light on why its value has fluctuated over time.
Origins and peg to US dollar
In the aftermath of World War II, Japan’s economy was in shambles.
To stabilize its currency, the yen was pegged to the US dollar at a fixed exchange rate of ¥360 per dollar.
This helped Japan rebuild its economy and regain its footing on the global stage.
Ending the peg and floating the yen
In the early 1970s, global economic conditions and pressure from other countries led Japan to abandon the fixed exchange rate system.
The yen was allowed to float freely in the foreign exchange market, its value determined by supply and demand.
This move marked a significant shift in Japan’s monetary policy and set the stage for future fluctuations in the yen’s value.
Appreciation of the yen in the 1980s
During the 1980s, the Japanese yen experienced a period of significant appreciation.
This was largely due to Japan’s booming economy and its growing influence in global trade. The strong yen made Japanese exports more expensive, leading to concerns about the competitiveness of Japanese industries.
The yen’s rise in value also impacted Japan’s tourism industry, as it became more expensive for foreigners to visit the country.
Weakening of the yen from the 1990s onwards
From the 1990s onwards, the Japanese yen started to weaken in value. This was a result of various factors, including Japan’s economic stagnation and deflationary pressures.
The Japanese government also implemented measures to weaken the yen in an attempt to stimulate export-driven growth.
However, this strategy had mixed results and led to concerns about the long-term stability of the yen.
It’s important to note that the value of a currency is influenced by a multitude of factors, including economic indicators, monetary policy decisions, and geopolitical events.
Understanding the historical context of the Japanese yen can provide valuable insights into its current value and future prospects.
Japan’s Export-Focused Economy
Japan’s economy has long been known for its strong focus on exports, which has played a significant role in shaping the value of the Japanese yen.
After World War II, Japan experienced what is known as the “post-war economic miracle,” a period of rapid economic growth and development.
During this time, the Japanese government implemented policies that aimed to promote export-oriented industries as a means of rebuilding the country’s war-torn economy.
Focus on manufacturing exports
One of the key factors that contributed to Japan’s export success is its strong manufacturing sector.
This focus on manufacturing exports has allowed Japan to establish a reputation for producing reliable and innovative products, which has helped boost demand for Japanese goods around the world.
Additionally, Japan has a strong tradition of craftsmanship and attention to detail, which has further enhanced the value of its exports.
The country’s reputation for producing precision-engineered products has made Japanese goods highly sought after in markets where quality and reliability are valued.
Trade surpluses with the US
Another factor that has contributed to the relatively low value of the Japanese yen is the trade surplus that Japan has consistently maintained with the United States.
For many years, Japan has exported more goods and services to the US than it has imported, resulting in a trade imbalance in Japan’s favor.
This surplus has led to a high demand for the Japanese yen from US businesses and consumers, which has helped keep its value relatively low compared to other currencies.
It is important to note that the value of a currency is influenced by a variety of factors, including interest rates, inflation, and geopolitical events.
While Japan’s export-focused economy is a significant factor in the value of the yen, it is not the sole determinant.
Therefore, it is necessary to consider a range of economic indicators and factors when analyzing the value of a currency.
For more information on Japan’s export-focused economy and the factors influencing the value of the yen, you can visit JETRO, the Japan External Trade Organization, which provides comprehensive data and analysis on Japan’s trade and investment activities.
The Bank of Japan’s Monetary Policies
The value of a currency is influenced by several factors, and one significant factor that affects the Japanese yen is the monetary policies implemented by the Bank of Japan (BOJ).
The BOJ is the central bank of Japan and is responsible for managing the country’s monetary system.
Quantitative easing and zero interest rates
One of the key monetary policies employed by the Bank of Japan is quantitative easing, which involves increasing the money supply to stimulate economic growth.
The BOJ achieves this by purchasing government bonds and other financial assets from commercial banks.
This injection of money into the economy helps to lower interest rates and encourages borrowing and spending.
In addition to quantitative easing, the Bank of Japan has also implemented a policy of maintaining low or even zero interest rates. By keeping interest rates low, the BOJ aims to make borrowing cheaper and promote investment and spending.
This policy can have the effect of devaluing the yen, as lower interest rates make holding the currency less attractive to foreign investors.
Explicit yen devaluation efforts
At times, the Bank of Japan has taken more direct measures to devalue the yen. This can be done through currency interventions, where the central bank actively buys or sells its currency in the foreign exchange market to influence its value.
By selling yen and buying foreign currencies, such as the US dollar, the BOJ can decrease the value of the yen relative to other currencies.
It is worth noting that explicit yen devaluation efforts can have both positive and negative effects.
While a weaker yen can make Japanese exports more competitive and boost economic growth, it can also lead to higher import costs and potentially contribute to inflation.
Abenomics and further stimulus
These policies aim to combat deflation and stimulate economic growth through a combination of monetary easing, fiscal stimulus, and structural reforms.
Abenomics has included additional rounds of quantitative easing and measures to weaken the yen further.
The BOJ has continued to purchase government bonds and other assets to inject liquidity into the economy.
These efforts have helped to keep interest rates low and support economic activity.
Purchasing Power Parity
Purchasing Power Parity (PPP) is a theory that helps explain the value of a currency in relation to another currency.
According to PPP, the exchange rate between two currencies should equalize the prices of a basket of goods and services in both countries.
In simple terms, it means that a given amount of money should have the same purchasing power in different countries.
Theory behind PPP
The theory behind PPP is based on the idea that, in the long run, exchange rates should adjust to equalize the cost of living between countries.
For example, if a Big Mac costs $4 in the United States and 400 yen in Japan, the exchange rate should be 100 yen per dollar to maintain the same purchasing power.
If the exchange rate deviates from this level, then there would be an opportunity for arbitrage, where individuals could buy goods in the cheaper country and sell them in the more expensive country, leading to market forces that would eventually correct the exchange rate.
Comparison to the US dollar and Euro
When comparing the Japanese Yen to the US dollar and the Euro, PPP analysis can provide insights into the relative value of these currencies.
For example, if the PPP exchange rate suggests that the Yen is undervalued compared to the US dollar, it means that goods and services in Japan are relatively cheaper than in the United States.
This can make Japanese exports more attractive and boost their competitiveness in international markets.
However, it is important to note that PPP analysis is not the only factor determining the exchange rate.
Other factors, such as interest rates, economic growth, political stability, and market sentiment also influence currency values.
Therefore, while PPP analysis is a useful tool, it should be considered alongside other indicators.
Limitations of PPP analysis
While PPP analysis provides valuable insights, it has its limitations. One limitation is that it assumes that goods and services are identical across countries, which may not always be the case.
Additionally, PPP analysis does not take into account non-tradable goods and services, such as housing, which can significantly impact the cost of living in a country.
Furthermore, PPP analysis is more relevant for long-term trends rather than short-term fluctuations.
Exchange rates can be influenced by various factors, including speculative trading and market volatility, which may not align with PPP predictions.
Currency Valuations Set by Forex Markets
Understanding why the Japanese Yen is worth so little requires an examination of the factors that influence currency valuations.
The foreign exchange (forex) market plays a crucial role in determining the value of a currency.
It is a decentralized market where participants, such as banks, corporations, and individuals, trade currencies. Here are some key factors that affect currency valuations:
Forces of supply and demand
The most fundamental factor in determining the value of a currency is the forces of supply and demand.
When there is a high demand for a currency, its value tends to rise. Conversely, when the demand is low, the value decreases.
In the case of the Japanese Yen, several factors contribute to its relatively low value in the forex market.
One reason is the economic policy of the Japanese government, which has aimed to keep the Yen weak to boost exports.
A weaker currency makes Japanese goods more affordable for foreign buyers, increasing demand for Japanese products and stimulating the economy.
Another factor is the historically low interest rates set by the Bank of Japan. Lower interest rates discourage foreign investors from holding Yen-denominated assets, reducing demand for the currency.
Importance of trade flows
The balance of trade and the current account surplus or deficit also play a significant role in determining a currency’s value.
Japan has consistently maintained a trade surplus, exporting more goods and services than it imports.
This surplus leads to an influx of foreign currencies, increasing supply and putting downward pressure on the value of the Yen.
Additionally, Japan’s economy heavily relies on imports, particularly for energy and raw materials.
This further increases the demand for foreign currencies, contributing to the relative weakness of the Yen.
Role of central banks
Central banks, such as the Bank of Japan, have the power to influence currency valuations through their monetary policy decisions.
These decisions can include adjusting interest rates, implementing quantitative easing measures, or intervening in the forex market directly.
The Bank of Japan has a history of implementing unconventional monetary policies, such as negative interest rates and massive bond-buying programs.
These measures aim to stimulate economic growth and combat deflation but can also weaken the Yen in the process.
Speculation and sentiment
Speculation and market sentiment can also impact currency valuations. Traders and investors make decisions based on their expectations of future economic conditions, political stability, and other factors.
The Yen is often seen as a safe-haven currency, meaning that investors tend to flock to it during times of global economic uncertainty.
This increased demand can temporarily strengthen the Yen. However, when sentiment shifts, and investors seek higher-yielding opportunities elsewhere, the value of the Yen can decline.
It is important to note that currency valuations are complex and influenced by various factors.
While the Japanese Yen may currently have a lower value compared to other currencies, it is essential to consider the broader economic and geopolitical context when evaluating its worth.
Future Outlook for the Yen
Continued monetary stimulus expected
The Japanese government has indicated that it will continue with its monetary stimulus measures in order to boost the country’s economic growth.
The Bank of Japan has implemented a policy of low-interest rates and quantitative easing, which involves buying government bonds and other assets to inject money into the economy.
This has led to an increase in the money supply and a weakening of the yen. It is likely that the government will continue these measures in the future to support economic growth and combat deflation.
Possibility of policy change
While the current trend is for continued monetary stimulus, there is also a possibility of a policy change in the future.
The Japanese government may decide to shift its focus towards more sustainable economic policies, such as structural reforms and fiscal consolidation.
This could lead to a strengthening of the yen as investors have more confidence in the country’s long-term economic prospects.
However, it is important to note that any policy change would need to be carefully managed to avoid disrupting the fragile economic recovery.
Impact of China and other factors
The value of the yen is also influenced by external factors, such as the economic performance of China and other major trading partners.
A slowdown in China’s economy, for example, can lead to a decrease in demand for Japanese exports and put downward pressure on the yen.
Additionally, geopolitical tensions and global economic uncertainties can also impact the value of the yen. It is important for investors to closely monitor these factors and their potential impact on the future outlook for the yen.
In summary, the Japanese yen is worth so little compared to other major currencies due to Japan’s export-dependent economy and the Bank of Japan’s policies to keep the yen weak to support exports.
While simple economics would suggest the yen should be much stronger based on Japan’s GDP and living standards, the priorities of Japan’s economy and central bank have overridden purchasing power parity theory.
With Abenomics and continued stimulus, a significantly stronger yen seems unlikely, barring a major policy shift.
This background provides a full picture of the complex dynamics that have shaped the modern valuation of the Japanese yen.