Billion-Dollar Blunder: Japan's Ineffective Battle to Bolster the Yen

 

Japan's opaque and arbitrary criteria for currency intervention have not only failed to stabilize the yen but have likely exacerbated its volatility, undermining the very goals of such interventions.

In 2022, the Japanese government undertook a significant financial intervention, spending over $60 billion from its foreign-exchange reserves in an attempt to bolster the weakening yen. This marked the first intervention aimed at strengthening the currency since 1998, triggered by the yen's decline to nearly ¥146 to the dollar. This move, however, did little to reverse the trend; instead, the yen continued to depreciate. In April 2023, the currency hit a 34-year low of ¥160 to the dollar, prompting further intervention from the government, which again attempted to prop up the yen through substantial purchases. Such actions underscore a persistent reluctance to accept market dynamics, despite historical evidence and economic theory suggesting that such efforts are both costly and ultimately ineffectual.

The underlying cause of the yen's depreciation can be traced to the widening interest rate differential between Japan and the United States. The Bank of Japan's conservative approach to monetary tightening has resulted in rates that barely moved from between minus 0.1% and zero to between zero and 0.1%. Contrast this with the robust economic environment in the U.S., where interest rates are substantially higher—over five percentage points greater. This disparity is reflected in the yields of government bonds: a ten-year Japanese government bond yields merely 0.9%, compared to 4.6% for a U.S. Treasury bond of the same maturity. Such differences are largely driven by divergent inflation outlooks in the two countries. While the U.S. Federal Reserve is concerned about sustained high inflation, Japan's central bank remains focused on escaping the deflationary pressures that have plagued its economy since the 1990s.

Japan's low-interest rates relative to the U.S. not only encourage the carry trade, where investors borrow in yen at low costs to invest in higher-yielding dollar assets, but also inherently weaken the yen. Theoretically, the yen should depreciate until the anticipated profits from such trades are no longer attractive, balancing out the currency's value. However, determining when a currency has reached its fundamental value is notoriously challenging, and the Japanese government's interventions appear to be based on arbitrary thresholds for acceptable currency volatility. These opaque criteria likely exacerbate the very volatility they aim to control.

The Japanese government’s intervention strategy also seems driven by factors beyond pure economic rationale. Political motives and national pride play significant roles, as a stronger yen would alleviate some of the cost pressures on imported goods, including energy, which weigh heavily on Japanese consumers. Despite Japan possessing nearly $1.3 trillion in foreign-exchange reserves, using these funds to combat market forces represents a questionable allocation of resources. Not only does it set the stage for speculative attacks—where traders anticipate government intervention and position themselves to profit from inevitable market corrections—but it also diverts these vast reserves away from potentially more productive uses.

Not only that, the interventions have occasionally been met with short-term success, as seen in late 2022 when U.S. bond yields declined, allowing the yen to temporarily strengthen. However, these are exceptions rather than the rule, and there is no guarantee that such conditions will recur. The general trend has been for the yen to resume its decline following intervention, underscoring the temporary and largely ineffective nature of these efforts.

Simply put, Japan's continued attempts to artificially bolster the yen through direct market interventions have proven both costly and ineffectual. These efforts have resulted in the squandering of vast sums—over $60 billion in 2022 alone—without achieving the desired stabilization of the currency. Such actions are fundamentally misaligned with the prevailing economic conditions, which are characterized by significant interest rate differentials and contrasting economic policies between Japan and other major economies like the United States. This persistent misalignment not only leads to the ineffective use of precious foreign-exchange reserves but also jeopardizes the credibility of Japan's financial leadership on the global stage.

A more prudent strategy would be for Japan to relinquish control over the yen's value to market forces, which more accurately reflect the economic realities of interest and inflation rates. Concurrently, Japan should concentrate on reinforcing its domestic economic framework. Focusing on enhancing economic fundamentals, such as productivity and growth potential, would naturally lead to a more robust yen over time. This approach adheres more closely to economic orthodoxy and offers a sustainable path to financial stability and growth. By adopting this strategy, Japan could ensure a firmer foundation for its economy, avoiding the pitfalls of costly interventions and fostering a stronger, more resilient financial environment.