June 2022

The yen’s plunge against the dollar is far from over, experts warn at FCCJ event

Artwork by Julio Shiiki

Japan is not suffering so much from a weak yen, but more from massive capital flight, as Japanese businesses and market investors turn their backs on the country and seek richer returns overseas. This suggests that the currency has a lot further to fall before the tide turns.

A recent FCCJ Deep Dive event on the yen proved to be an eye-opener in revealing why the currency has plunged to its lowest level in 20 years against the dollar in nominal terms, and its lowest in 50 years after adjustment for inflation.

The yen is "on track towards a parabolic move, with global and Japanese macro players set to get increasingly aggressive in betting on an overshoot towards 150-160 to the dollar", said panelist and veteran Japan financial analyst Jesper Koll.

“With the Bank of Japan’s governor, Haruhiko Kuroda, digging his heels in by keeping monetary policy easy and interest rates low, and the U.S. Federal Reserve now floating the idea of accelerating the pace of rate hikes to possibly 75 basis points a pop, it very much looks like the yen’s slide is just beginning,” Koll added.

Fellow panelist Tohru Sasaki, who heads Japan Markets Research with JPMorgan Chase Bank Japan and JPMorgan Securities Japan, noted that when he last spoke at the club in 2007, the dollar/yen rate was around 125 – not so very different from now.

But the causes of relative yen weakness then and now are completely different, the former Bank of Japan official said. While a weak yen gave little cause for concern 15 years ago, Sasaki said he was "worried" about where the currency was heading this time around.

Both Sasaki and Koll, former chief economist for US investment banks Merrill Lynch Japan Securities and JP Morgan Japan Securities, suggested tht the yen could plunge as far as 150 to the dollar or even lower unless Japan's economic and financial fundamentals changed.

Currency market intervention by Japanese authorities is unlikely on any significant scale, and even if attempted is unlikely to turn the tide. Meanwhile, concerted official intervention by the U.S. and others is almost certainly not on the cards, the panelists suggested.

In the past, a weak yen has largely reflected "carry trade" activity, whereby the yen is borrowed relatively cheaply to finance investor purchases of higher-yielding currencies, and then sold once the transaction has served its purpose and is reversed, Sasaki recalled.

That resulted in temporary weakness, but the yen’s current plight is due to structural changes in Japan, he added. After the Tohoku triple disaster in March 2011, Japanese manufacturers shifted more production overseas or sourced products from overseas to strengthen their supply chains.

That shift means that large Japanese manufacturers no longer enjoy gains in price competitiveness from a weak yen. As a result, Japan's once massive trade surpluses have turned to trade deficits, Sasaki said.

Much of the increased income generated by direct investments in overseas production is being reinvested overseas rather than repatriated to Japan, where it would help boost the yen. "The yen is cheap now but no one wants it” he said.

Meagre yields on investments in Japan, where a low, zero or negative interest regime has prevailed for years, discourages capital repatriation. To complicate matters, Japan's earnings on inward tourism, which had surged to $11.3 trillion by 2020, have crashed during the Covid-19 pandemic.

The importance of capital flows in determining the exchange rate of the yen in relation to the dollar and other currencies can hardly be overestimated, the speakers said. And it is not just a question of capital flight by Japan's manufacturing sector.

Japan's financial institutions – including leviathans such as the Government Pension Investment Fund (GPIF) – the biggest of its kind in the world with assets of $1.5 trillion – and Japan Post, as well as insurance companies that collectively control $3.5 trillion, are shifting money into overseas investments.

"The yen will turn when Japanese investors begin buying local assets, for example, when  the GPIF and other local stewards of capital cut non-yen allocations in favor of yen equities and other yen risk assets [such as in] private equity or venture capital," Koll said.

“The most likely trigger, unfortunately, is a crash on Wall Street,”' warned the investment veteran, who nowadays serves as expert director at the Japan-based Monex Group, and is an investment committee member of the Japan Catalyst Fund.

"The yen`s fall from grace will stop and reverse exactly when Japanese investors begin buying their mother markets here in Japan in the realistic expectation that Japanese corporate leaders will begin to actually invest in both human and physical capital here at home."

But other forces could push the yen in the opposite direction and cause the currency to plunge further, Sasaki warned, adding that would raise questions over would happen to Japan's ¥1,000 trillion in household savings.

These are parked mainly in  low-yielding Japanese bank accounts or under proverbial mattresses, he said. As Japanese investors, particularly younger ones, become more tech savvy and begin buying foreign currencies via their smartphones, a new tsunami of capital outflows could follow.

In that case, the ¥150 trillion or so of official foreign exchange reserves held by Japanese authorities would be of little help in defending against the further depreciation of the yen, even in the unlikely event that intervention is tried on a large scale, Sasaki said.

The overall message from the event was that the yen is doing its own “deep dive”, and that the plunge risks spiraling out of control.

Anthony Rowley is a columnist and contributor for The South China Morning Post.