Japan’s economy is approaching a historic watershed

Former Japanese finance minister Eisuke Sakakibara, who was in charge of exchange rate intervention in the second half of the 1990s and was known as “Mr. Yen,” reiterated his long-held view that “a strong yen is in the national interest” in a speech at the Japan Press Club in late November. “. This is a quote from the then U.S. Treasury Secretary Rubin, who advocated “a strong dollar in the national interest” on the international financial stage in the same era.

Currency is a mirror that reflects the credibility of a country. The yen, in particular, will have a critical moment in 2024. It is not just Japan’s logistics sector (where manpower shortages will intensify in 2024), but the yen faces two looming 2024 problems.

The first is the potential loss of its throne as the world’s largest creditor. Japan’s net foreign assets stand at 418 trillion yen at the end of 2022. Germany, in second place, was 389 trillion yen. In dollar terms, they are $3.1 trillion and $2.9 trillion, respectively. Theoretically, the increase or decrease in the current account balance and net foreign assets is almost the same. Therefore, if the current account surpluses projected by the International Monetary Fund (IMF) are used as the basis for projecting net external assets at the end of 2023 and the end of 2024, they will be US$3.3 trillion and US$3.4 trillion for Japan and US$3.2 trillion and US$3.5 trillion for Germany. Both countries would reverse in 2024.

Japan’s ability to earn money through exports has been relatively weakened, and the current account surplus has come to depend on investment earnings abroad. However, there are signs of significant change in this area as well.

On 24 November in the Shanghai foreign exchange market. The yen depreciated against the RMB at one point to 4.7749 yuan for 100 yen, hitting the lowest point for the RMB since the introduction of the managed floating exchange rate system in 2005. Although dragged down by the depreciation of the yen against the U.S. dollar, what should not be overlooked is the structural change in Japan’s current account balance with China.2022 After January to March, Japan continued to run a deficit, with the cumulative deficit up to April to June 2023 reaching about 4.5 trillion yen. It offsets nearly 20% of the surplus with the U.S. during this period.

The main reason for this is the decline in semiconductor-related and other exports, which has led to a widening of Japan’s trade deficit with China. In addition, the deceleration of investment income such as dividends from local Chinese subsidiaries should not be ignored. China’s economic downturn and China’s tightened controls are casting a shadow.

Born in Turkey, Emin Yurumazu, an economist at Japan’s Compound Eye Economy Juku, said worriedly, “I think the Nikkei average will reach 300,000 points, but this prediction is not envisioning a Turkish lira-ised Japan. That situation is not good.”

Liraisation is the ironic coincidence of the future of the yen with the Turkish legal tender, the lira. Against the backdrop of a prolonged “double deficit” in the fiscal and current account balances, Turkey continues to maintain a benchmark interest rate below the rate of inflation (negative real interest rate), leading to a vicious circle of rising prices and currency depreciation.

Comparing the depreciation rates of the real effective exchange rate of the Turkish lira and the Japanese yen from March 2020 to October 2023, the real effective exchange rate of the Turkish lira is 21 % and that of the Japanese yen is 29 %. The real effective exchange rate refers to an index derived from calculating the relative strength (purchasing power) of currencies, taking into account factors such as price changes and trade volumes.

The Turkish lira plunged more than 70 % in nominal terms during the same period due to annual inflation of more than 60 %, which, if its effect is excluded, depreciates at a smaller rate than the yen. Japan’s Fukuoka Financial Group chief strategist said that the flip side of the yen’s substantial weakness is obvious. Although Japan is the world’s largest creditor, but its total government debt is much higher than Turkey.

The Bank of Japan (central bank) of the capital cycle statistics show that the net outflow of funds from Japan to overseas through the securities investment trust in January 2000 to June 2023 reached a cumulative amount of 105 trillion yen. It can be confirmed that capital outflows accelerated in the situation of yen depreciation from 2005 to 2007, from 2013 to 2015, and from 2020 onwards. The implementation of the new tax exemption system for small investments (NISA) in Japan from January 2024 is likely to exacerbate this outflow of personal funds. This is the second 2024 problem.

Precisely because we are in an era of growing globalisation, the credibility of the yen, which is the basis for attracting capital flows to Japanese companies, must not be shaken. The reason why overseas investors are buying Japanese stocks despite the depreciation of the yen is because of a sense of reassurance that Japan is the world’s largest creditor. If this weakens, it is possible that the earnings and share prices of Japanese companies will be converted into dollar terms. In that case, the earnings-enhancing effect of yen depreciation will be difficult to work.

Whether it is freedom from deflation or a strong yen, to claim that it is in the national interest, it will only be a picture of the cake if it lacks the tangible feelings of the people. A historic watershed for the Japanese economy is approaching.