So, we have looked at some of the ways that the yen to dollar relationship has been managed, or mismanaged over the decades since the war, now let’s look at some of the economic factors which also influence the strength or weakness of the yen today. Until the early 1990’s, the Japanese economy was considered to be a modern miracle by many observers, with its success having been based largely on government and industry co-operation, a strong work ethic, a mastery of high technology and a comparatively small allocation of GDP to defence ( less than 1%). Japan currently ranks as the fourth largest economy in the world after the US and China who are its largest trade partners. In the 70’s and 80’s the economic growth was spectacular.

This growth slowed dramatically in the 1990’s largely as a result of over investment in the 1980’s and domestic government policies designed to create economic growth based on speculation in the financial markets and property, rather than in construction and manufacturing ( largely what is happening currently in the UK). This is often referred to as the ‘bubble economy’ . The banking crisis that followed led to a collapse in stock markets and real estate values, with a huge increase in bad debt and company closures. The Government and the Central Bank are still trying to recover from this crisis, having introduced the lowest interest rates in the world in an attempt to rebuild confidence.

Given that the bubble economy was created between 1986 and 1990, you might wonder what possible relevance this could have to today’s exchange rates, and the strength or weakness of the Japanese yen. The answer is very simple – the effects are still being felt in the Japanese economy today and quite simply it is one of the most famous economic slumps in the history of modern economics. Nearly 20 years later, the once booming economy is only now starting to recover with a banking industry that virtually collapsed, and only survived due to the intervention of the Bank of Japan. Consumer confidence was virtually destroyed, with land and house prices collapsing, financial markets in freefall, and companies going bust. And the single reason for this economic collapse – cheap money! How this echoes the current woes in the US and UK markets and the debacle of the sub prime mortgages. Given the length and depth of the recession in Japan following the same model, it is little wonder that many economists are now wondering on the number of banking failures and collapses there may be in the US markets. Only time will tell, but there will almost certainly be more casualties in the coming years.

As I said earlier, the prime reason for the bubble was cheap money. With more money in banks, loans and credit became easier to obtain, and with Japan running a large trade surplus, the yen was able to appreciate against the US dollar and others. With an appreciating yen, financial assets became very lucrative, which in turn led to inevitable speculation, particularly in stocks, shares and property, with the banks offering increasingly risky loans. The bubble finally burst in the early nineties and Japan remained in recession for several years thereafter, a period that is often referred to as the ‘lost decade’. Nominal GDP growth which had been around 7% during the bubble, fell to zero. Amongst the hardest hit were the commercial banks who had extended large amounts on mortgages for property financing, or for speculation in the stock markets. Eventually these losses filtered through to the balance sheets, with several brought to the point of collapse. So what was the effect on the Japanese yen following this turbulent period, and where are we today?

Japan is particularly vulnerable to currency fluctuations because its economy depends so heavily on exports for growth. Japan’s economy grew by 2.1% last year, and more than half of that growth came from exports. A weaker dollar makes Japanese companies’ products more expensive overseas, while reducing the value of their dollar-based earnings when converted into yen. Following the bubble economy the yen declined sharply, reaching a low of 134 yen to dollar in February 2002. The Bank of Japan’s policy of zero interest rates discouraged yen investments whilst simultaneously encouraging speculators in the currency markets with the carry trade, borrowing yen and investing in better paying currencies. This further devalued the yen and as recently as 2007, it was generally agreed that the yen is 15% undervalued against the US dollar and possibly as much as 40% against the Euro. If the dollar continues to fall, “we now face a considerably high possibility of having a situation that can be defined as a recession,” said Hiroshi Shiraishi, a Lehman Brothers economist in Tokyo. Such is the sensitive nature of the Japanese economy. That was 2007 – as we can see dollar weakness has now returned since mid 2007 against the yen in the last year, with the yen falling below the psychological barrier of 100 yen to the dollar. This is the point at which the Bank of Japan is likely to intervene in order to protect their export markets from further erosion due to their products becoming uncompetitive overseas. Despite assurances to the contrary, it is my belief that the BOJ can, and will intervene – they cannot afford to watch their economy enter another long period of sustained recession and I believe that the yen to dollar rate will rebound back to 105/110 supported by the BOJ in the not to distant future.