The Currency Crisis in Japan: A Story Just Beginning

Introduction

On Tuesday, we briefly discussed the sudden crash and subsequent recovery of the Japanese Yen, which took place between Friday and Monday, 26-29 April, on the GnS Economic’s Deprcon Outlook. In this piece, I will delve deeper into the reasons behind the crash, which have roots in the post-WWII growth model of the Japanese economy, culminating in the financial crash of the early 1990s. These factors suggest that Japan's currency crisis is far from resolved.

Boom and Bust

Japan's economy was left in ruins after the Second World War, necessitating a significant reconstruction effort. The country also transitioned to a democratic governance model, establishing a stable society conducive to investment. The post-WWII economic boom was driven by financial regulation that kept the nominal interest rate below inflation and successful economic reforms that supported neutral recruiting of labor and education. The Ministry of Finance imposed a cap on both lending and deposit rates, sparking a significant investment boom. The export sector expanded rapidly, with the composition of exports evolving from toys and textiles to bicycles and motorcycles, and eventually to steel, automobiles, and electronics.

The Bailout

Following the real estate sector crash, most of Japan's large banks remained bankrupt throughout the 1990s. It was customary in Japan to socialize the losses of the banking sector, and regulatory authorities were hesitant to shut down banks deemed bankrupt.

Drag on the Economy

When a private sector is overrun with so-called zombie companies, which can only survive thanks to easy credit, it becomes a serious drag on the economy. This is clearly evident in the growth of Japan's Total Factor Productivity.

Currency Crisis

Currency and debt crises are often closely linked. This is because the foreign exchange value of a currency reflects the trust of international investors and businesses in the keeper of the currency, i.e., the country's government.

Conclusions

The bailout of the Japanese economy in the early 1990s, which led to a slump in productivity and resulted in the Japanese government's high level of debt, is the main cause behind the 'flash crash' of the Japanese Yen. On April 26, it appears, a 'sunspot' triggered the selling. The response of the monetary authority, i.e., the BoJ, was to start to defend the yen at a USDJPY pair of 160. Its intervention (buying of yen) pushed the pair to under 153 on May 3, where it has started to creep back up.

As the underlying problems of the Japanese economy have not disappeared, the attack on the yen in the markets is likely to continue and escalate, again, at some point. The question is, what is the breaking point in the USDJPY pair after which investors start to flee? Moreover, we should remember that monetary authorities have their limits, while markets don’t. Thus, it is very likely that the currency crisis of Japan has but just started.

Final Thoughts

This article provides a detailed examination of the ongoing currency crisis in Japan. It's clear that the country's financial troubles are far from over, and it's crucial to consider the potential global implications. What are your thoughts on this matter? Please share this article with your friends and discuss. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.