The Economy Behind the Japanese Yen

More than two thirds of the foreign exchange market consists of only seven currencies, and one of the largest of those currencies is the Japanese Yen. That is not surprising when one considers that Japan is one of world’s biggest economies and the fourth largest exporter measured in U.S. dollars. 

Like all the nations representing the largest currencies, Japan has a central bank. Theirs is called the Bank of Japan and it acts according to a mandate to foster economic growth and avoid inflation. For Japan however inflation has not been a problem, instead they face the opposite and sometimes just as serious problem of deflation. In order to stimulate economic growth, the Bank of Japan has tried to keep interest rates low to encourage lending and economic activity, sometimes going so low it has been negative at some points over the past decade.

Yet these policies have consistently failed. Although Japan has a large economy it is not robust, and despite occasional spurts of growth it has had recurring recessions. This has resulted in what observers have called “a lost decade” in which Japan just seems incapable of breaking out of the economic doldrums.


Japan’s Challenge

Part of Japan’s problems is the demographics. An aging population, low birth rates and restrictive immigration laws prevent young people from other countries from replacing older workers, making it difficult to spark a revival. The Bank of Japan’s policy of intervening to keep their currency low in order to make their exports more competitive definitely has an impact on the Forex market. Such major and repetitive interventions in the third most often traded currency have undermined the yen’s traditional role as a back-up reserve currency.

Fortunately Japan can probably remain a pretty safe haven because of its still remaining strengths such as its big trade surpluses. However, what many observers find most intriguing about Japan are the ominous parallels between Japan’s growth problems and recent economic policies in the United States. Like Japan, the U.S. is making repeated market interventions in both its money supply plus economic stimulus packages, the exact same policies that have failed so consistently in Japan. So while the Japanese may still muddle along with anemic growth with little consequence outside their borders, such longterm stagnation in the U.S. would have a very adverse effect both on the Forex market and the world’s economy as a whole.