The Japanese yen is rapidly becoming weak, dropping to the 120-yen range to a U.S. dollar for the first time in some six years. The direct cause of this is the widening gap between interest rates in Japan and the United States. The U.S. Federal Reserve has raised its interest rates, while the Bank of Japan (BOJ) plans to maintain its ultra-easy monetary policy, leading to the yen's sell-off.
Japan has preferred a weak yen for its economy. This leads to export growth, and Japanese companies' profits increase when the revenue from their foreign subsidiaries is converted into yen. It also encourages people overseas to come to Japan, from which tourist destinations benefit.
The idea that a weak yen is good for Japan's national interests has been the norm among successive administrations and in financial circles. A typical example of this was former Prime Minister Shinzo Abe's flagship economic policy dubbed "Abenomics." It used the ultra-easy monetary policy to encourage a weak yen, in a bid to aid the recovery of the Japanese economy. Current Prime Minister Fumio Kishida has inherited this policy.
That being said, this time the negative aspects of the yen's depreciation are more noticeable than its benefits.
Japanese companies are moving their manufacturing hubs outside Japan, meaning that positive effects of the weak yen on export growth are not as significant as they used to be. These companies are increasingly reinvesting the profits they made on foreign soil locally, making it hard for the money to come back to Japan. And the coronavirus pandemic means Japan can't expect much from inbound tourism.
On the other hand, there are mounting concerns that domestic price increases will be further accelerated. Prices of commodities including crude oil and grain are skyrocketing amid Russia's invasion of Ukraine. A weak yen will further increase imported goods prices, possibly squeezing people's livelihoods in Japan.
What is most concerning is the continuous decline of the yen's status in the international market. The yen's real effective exchange rate, an index showing the strength of a currency, is at a 50-year low. This means that the yen's purchasing capacity has fallen internationally, and it's now less than half its peak seen in the mid-1990s.
In past crises, the world bought the Japanese yen as it was seen as a safe currency. This time around, however, that kind of movement is yet to be observed.
Even if the yen's depreciation continues, there is only so much to be done to shift the course, as ending an ultra-easy monetary policy is no easy task.
The latest crisis has highlighted the vulnerability of Japan's economy management, and this may be fueling worries over the negative aspects of a weak yen. It's time the Japanese government and the BOJ squarely faced the problems in a policy that continues to rely heavily on a depreciated yen.