You don’t need to be a financial expert to see what’s happening with the yen. Recent sharp rises on July 11th, 12th, and 17th suggest that the Bank of Japan (BOJ) might be intervening in the currency markets. These interventions, which have pushed the yen to ¥156 against the dollar, mark a 4% increase and a slight recovery from its 37-year low earlier in the month.
Preliminary figures indicate the central bank may have sold upwards of $35 billion in foreign-exchange reserves on July 11th and 12th. This would be in addition to the $120 billion spent on interventions over the past two years, with a significant portion occurring between late April and late May. While these interventions are a setback for currency traders, they may not have a lasting impact on the exchange rate, much to the dismay of officials and the delight of tourists now visiting Japan in large numbers.
The ongoing weakness of the yen is primarily attributed to the divergence in monetary policies between Japan and the United States. Despite the BOJ’s slight interest rate increases, they pale in comparison to the Federal Reserve’s hikes, leading investors to favor the dollar. Curiously, even as the gap in government bond yields between the two countries has narrowed significantly since October, the yen has depreciated an additional 4% against the dollar.
A potential reason for the yen’s decline could be the effective corporate governance reforms initiated during Abe Shinzo’s second term as prime minister, which encouraged Japanese companies to focus more on investment returns and divest non-essential shareholdings. This shift has seen Japanese stocks outperforming those of other wealthy nations, except the U.S., over the last decade.
However, this focus on returns has also driven Japanese companies to increase their investments abroad significantly. In the year ending May, Japanese direct investment overseas exceeded foreign direct investment into Japan by $178 billion, a substantial increase from $72 billion in 2010. Despite the volatile nature of portfolio investment flows, direct investment is clearly trending outward.
Notably, Taiwan’s TSMC’s decision to build factories in Kumamoto province is an exception rather than the norm, as Japan’s cultural and language barriers deter many potential foreign investors. Japan’s foreign direct investment stocks are among the lowest globally, representing only 5% of GDP, placing it between Kiribati and Burundi and well below the global average of 44%.
The shift in how Japanese companies handle overseas earnings also influences the yen. Instead of repatriating profits, many now opt to keep them in foreign bonds and investments. While Japan displays a trade deficit of ¥4 trillion, its companies’ overseas earnings create a substantial surplus of ¥37 trillion. However, if these earnings are not converted back to yen, they do little to support the exchange rate, rendering Japan’s consistent current-account surplus somewhat illusory.
Over the long term, Japan’s potential as a diversified supply chain hub may bolster the yen. More immediately, a faster-than-expected reduction in U.S. interest rates could narrow the yield gap further, supporting the currency. Nonetheless, with Japan’s labor force diminishing and companies becoming more efficient, downward pressure on the yen is likely to continue, benefiting Americans eager to enjoy Japan’s culinary delights.
