Why Japan is unable to arrest its economic decline, despite a weak yen

As instruments of capital flight, Japan’s business corporations are largely responsible for the badly skewed yen exchange rate
Japan ought not to be dependent on a weak currency. A stronger yen could deliver the wake-up call the economy needs

Anthony Rowley

Published: 8:45am, 26 Jul, 2021

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Kazuo Ishiguro’s poignant novel, The Remains of the Day, is all about genteel decline and that is perhaps a good way to describe the current state of Japan (the land of Ishiguro’s birth) as it slides into a sustained economic decline with the full impact being masked by a weak yen.

As JPMorgan’s Tohru Sasaki notes in a recent report, the yen is now the “weakest currency among majors by a clear margin”. In real effective exchange rate terms, the yen is back where it was in the 1970s. This means, according to Sasaki (formerly with the Bank of Japan), that although the yen now stands at around 109 to the dollar, the yen-dollar rate should be nearer to 69, adjusted for price changes.

Currency hawks in the US administration who might pounce on China for permitting undervalued exchange rates have been silent on Japan. But Tokyo is an ally and Washington’s “unsinkable aircraft carrier”, to quote former Japanese leader Yasuhiro Nakasone.

Maybe currency watchdogs don’t care about real effective exchange rates. But the causes and effects of the anomaly of Japan’s case are of interest to anyone who wonders why its economy continues its seemingly inexorable decline.

A nation which once seemed poised to become the world’s leading economic power has instead seen export volumes fall despite a weak yen, and a reliance on cheap-yen tourism.

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Yes, the demographics are working against Japan, which has one of the fastest-ageing populations in the world, and the nation’s restrictive immigration policies do not compensate for its falling number of people. But that isn’t the whole story.

A declining population implies declining demand and price disinflation, which is precisely what Japan has been suffering for decades despite the best efforts of the Bank of Japan under governor Haruhiko Kuroda.

Consumer prices in Japan have risen only 2.6 per cent in the past 20 years, compared to 40-50 per cent in other countries, according to JPMorgan. This implies that the exchange rate of currencies with higher inflation rates than Japan’s ought to have fallen against the yen.

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So why has the opposite happened? It is not because of foreign exchange intervention by Japan to weaken the yen. The last big concerted intervention was the 1985 Plaza Accord, which was designed to strengthen, not weaken, the yen.

At that time, Japan was the “enemy” because of its competitive threat to the US. Japan went along with the Plaza Accord and maybe that’s why the US is turning a blind eye to the weak yen now. Besides, China is the new enemy.

But Japan’s business corporations are also largely responsible for the badly skewed yen exchange rate. They have been instruments of capital flight. Sasaki notes that, since the days of Abenomics, which began when Shinzo Abe became prime minister in 2012, “Japanese companies have sharply increased their foreign direct investment or FDI”.

This process leads to capital outflows, which in turn tend to weaken the yen. But the situation has been exacerbated by the fact that Japanese companies have preferred to keep their overseas earnings offshore rather than repatriate them.

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“The amount of earnings retained by Japanese companies’ overseas subsidiaries has risen to more than 40 trillion yen” (US$362 billion), according to JPMorgan. They have grown by 4 trillion yen over the past decade alone.

Had these corporate earnings been repatriated and used to finance new domestic investment, or paid out in the form of higher wages to company employees, that would very likely have boosted both industrial productivity and consumption in Japan.

That has not happened, however, and instead as Sasaki notes, “In the past 30 years, the average annual income has not risen in Japan in nominal or real terms but has increased substantially in other major countries.”

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As a result, “Japanese average annual income has become the 20th highest among OECD countries in JPY terms, significantly down from third place in 20 years ago”.

Another aspect of yen decline is that it reflects what JPMorgan calls “offshore investors’ selling of Japanese stocks on disappointment in Japanese companies”. Those “who bought a net 20 trillion yen of Japanese stocks on expectations for Abenomics subsequently sold half”.

Can the weak yen continue? JPMorgan analysts think not. Japan is approaching an election season in autumn and Japanese firms tend to repatriate funds at times of political insecurity. Also, pension funds are repatriating funds now.

Japan ought not to be dependent on a weak currency. A stronger yen could deliver precisely the kind of shock or wake-up call that the Japanese economy needs. Decline, whether genteel or not, should not be an option, however much the impact is shielded from sight.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs