The biggest monetary policy experiment in modern history is clearly not going well as the Japanese yen plunges to 32-year lows.
The eerie silence from the Bank of Japan as the yen tumbles to 150 to the dollar, and likely beyond, really has global markets guessing about Tokyo’s plan to tame things. Yet Governor Haruhiko Kuroda’s reticence says more about Japan’s plight than BOJ officials care to admit: Asia’s No. 2 economy has essentially lost control of exchange rates.
A favorite social media meme these days is an image of how something started years ago next to one depicting how it’s going. In the case of the Kuroda-run BOJ, we’re talking quite a split-screen from 2013 until today.
Kuroda, you can argue, started out exactly as intended. When he arrived at BOJ headquarters, Tokyo was already 15 years into his weak-yen policy plan to boost gross domestic product. In the late 1990s, Kuroda was a top Ministry of Finance official overseeing currency policy. From the late 1990s, the BOJ has a succession of governors who favored a soft yen—from Masaru Hayami to Toshihiko Fukui to Masaaki Shirakawa.
In 2013, the ruling Liberal Democratic Party turned to Kuroda, a globally respected economist, to supersize the effort. He did just that, hoarding government bonds and cornering the stock market via epic purchases of exchange-traded funds. By 2018, the BOJ’s audacious experience with so-called “modern monetary theory” swelled the balance sheet to the point where it topped Japan’s $5 trillion of annual GDP.
Trouble is, that’s all Tokyo has really done since 2013. Back then, Kuroda trusted Prime Minister Shinzo Abe to make good on bold reform pledges. Abe promised to internationalize labor markets, reduce bureaucracy, increase productivity, support startups and empower women. Sadly, it was a ginormous bait-and-switch. Abe’s plan was aggressive yen devaluation so that he didn’t have to do the heavy lifting on reforms.
How’s it going? Ask Kuroda, who’s grappling with a yen in virtual free-fall.
The kind way to explain the yen’s trajectory is that it’s more about the Federal Reserve than the BOJ. To be sure, the widening gap between US and Japanese yields is pressuring the yen downward. But the real driver is an aging, highly indebted economy pursuing a one-note economic policy government after government, decade after decade.
Japan now faces two problems in currency-trading circles. One, it literally has few options to put a floor under the yen—and speculators know it. If the BOJ were to raise interest rates, or the BOJ just “tapered” asset purchases, a deep recession wouldn’t be far behind. And unless the Fed and European Central Bank participate, currency intervention is pointless.
Two, how 25 years of prioritizing a weak yen over structural change deadened Japan’s animal spirits. When Argentina or Vietnam devalue exchange rates, the aim is to jolt the system. When a giant, advanced economic system like Japan’s does it, it enables complacency.
Imagine where Japan might be in 2022 if it spent the last 10-20 years following the German model of reinvention. Germany is an example of a high-cost nation with a decent track record of using periods of currency strength to alter production processes and increase productivity. The idea is not to let a market-driven shock go to waste. Sadly, Japan has gone the other way, prioritizing massive corporate welfare.
Now, current Prime Minister Fumio Kishida is assuming the position. As his government reached the one-year mark earlier this month, Kishida announced his team is leaning towards the falling yen.
“I will press ahead with strengthening an economic structure that capitalizes on the weak yen,” he said October 3. “While drawing out the maximum benefits of the weak yen, I will proceed with policies that return them to the people.
Yet if those “benefits” didn’t materialize in 2012 or 2002, what makes Kishida think this time will be different? It won’t be, and currency traders know it. That’s why any further intervention efforts will fail in the longer run.
The question, of course, is how much further a yen down more than 30% this year might go. Might it go to 160 to the dollar, as it did in 1990? Is the global economy ready for that?
Periods of extreme yen moves tend to go badly for the global financial system. More than 20 years of quantitative easing morphed Japan for better or worse into the creditor nation of choice. Yen borrowings are then carried over into higher-yielding bets from the US to South Africa to Poland to India. When the yen suddenly zigs, assets from stocks to bonds to real estate to cryptocurrencies zag a world away.
In other words, if Japan’s monetary experiment goes spectacularly awry, the entire globe will feel the fallout. Perhaps sooner than you think.