Why is the yen still so weak?
Newly alluring yields on Japanese bonds have not propped up the currency
Illustration: Álvaro Bernis
IF ONE BELIEF unites Japan-watchers, it is that its economy is abnormal.
The country is home to world-class firms but clocks little economic growth to speak of.
Its net public debt to GDP of 130% is among the world’s highest but its interest rates are among the lowest.
And even as the Bank of Japan (BoJ) has raised them from -0.1% to 0.75% over the past two years, which ought to lure return-hungry capital and strengthen the currency, the yen looks nearly as limp as in mid-2024, when it hit a 38-year low.
On a trade-weighted basis and adjusting for inflation, it is among the world’s limpest, notes Robin Brooks of the Brookings Institution, a think-tank.
So limp, in fact, that rumours swirl of Japan and America considering a joint intervention to prop it up.
Some, including Mr Brooks, argue that the yen’s persistent weakness reflects a slow-motion fiscal crisis.
In an effort to end deflation the BoJ has for years been buying Japanese government bonds (JGBs).
This has kept a lid on yields—and thus the government’s debt-service costs.
Although the central bank’s bond-buying has been net negative (after accounting for the natural pace of bond redemptions) since 2024, it still picks up ¥2.9trn ($19bn) of JGBs a month.
So yields remain low and the demand for yen soft.
Is Mr Brooks right?
The good news is that on many measures Japan’s fiscal situation has improved lately.
Net debt to GDP has shrunk every year since 2020.
The primary budget deficit (which excludes interest payments) was a manageable 0.9% of GDP last year, down from 2.4% in 2019.
The government has inflation to thank.
After years at zero or below, annual inflation has spent much of the past year above 3%, higher than in many big economies.
Rising prices translate more quickly into higher tax receipts than into higher spending.
They also boost nominal growth, which comfortably exceeds the low coupons Japan has locked in over the years on its debt.
As a result, debt has grown more slowly than GDP, even with a small primary deficit.
Another way to make the point is to consider interest rates in real terms.
In March 2024 the BoJ scrapped its policy of “yield-curve control”, under which it bought unlimited quantities of bonds to pin the ten-year yield below 1%.
Since then that yield has risen from 0.7% to 2.3%, putting it within striking distance of the 2.8% on Germany’s ten-year bunds.
Over the same period, however, inflation has come to look more entrenched.
As a result, inflation-adjusted yields still look low, as befits a low-growth economy.
The ten-year real yield in Japan is just 0.2%, compared with 1% in Germany and nearly 2% in America.
On both a five- and ten-year horizon, the gap with America, of about two percentage points, is stuck roughly where it has been for four years.
Low real yields give Japan some fiscal wriggle room.
It also enjoys buffers.
Its public sector owns a gargantuan pile of assets, from land to foreign corporate bonds, not all of which are counted in official net debt statistics.
One estimate, by Yili Chien of the Federal Reserve Bank of St Louis, Wenxin Du of Harvard Business School and Hanno Lustig of Stanford University, puts the net liabilities of the consolidated public sector in 2024 at just 78% of GDP.
Assets could be sold outright, or the cashflows from them diverted, to pay down debt.
Inflation itself might provide another explanation for the yen’s weakness.
Since 2024 prices rose faster in Japan than in all three of its biggest trading partners—China, America and the EU—about two-thirds of the time.
This has caused the yen to lose purchasing power more quickly than the yuan, the dollar or the euro.
The bad news is that this alternative story has holes.
The extent of the yen’s weakness goes far beyond what recent inflation can account for.
In fact, the yen is dramatically cheaper than it should be based on purchasing power alone.
According to our Big Mac index, it is roughly 50% undervalued.
Fancier estimates look similar.
Goldman Sachs, a bank, reckons that long-run fair value is about ¥90 per American dollar, compared with ¥153 now.
Perhaps investors fear what comes next.
Japan has three vulnerabilities.
The first is real interest rates.
If the BoJ does its job, inflation will fall to 2%.
That might raise real yields and put pressure on the budget, especially if getting to the target requires still-tighter monetary policy.
Academics estimate that in the 2010s the central bank’s bond-buying depressed ten-year yields by between one and three percentage points.
The effect, argues Mr Lustig, has been to hugely subsidise funding costs for Japan’s public sector.
It is not clear if this can be unwound without sparking a crisis.
A Nippon steal
A second problem is the flipside of the country’s asset hoard, much of which is held abroad.
Its investments make it look a lot like a hedge fund that has issued cheap debt to pursue high returns.
Mr Chien and his colleagues argue that low interest rates, a weakening yen and strong asset-price growth have earned Japan an average of 6% of GDP per year over the past decade, helping to pay for deficits.
But changing conditions could put these flows into reverse.
“The sizeable duration and currency mismatch on the public sector’s balance-sheet exposes Japan to significant mark-to-market losses that could trigger a fiscal crisis and even a run on the Japanese currency,” they write.
Yet Takaichi Sanae, the prime minister, has called a snap election to seek a mandate for fiscal expansion.
A fiscal stimulus would be inflationary.
The extra monetary tightening it would make necessary would rebound on the budget.
That Japan has enjoyed the upsides of higher inflation does not mean it can afford to throw caution to the wind.
If real interest rates follow nominal ones upwards, it will learn that normality has downsides, too.
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