The yen's fluctuation and its geopolitical ripple effects: A new normal in Indo-Pacific

WRITTEN BY DR SEOHEE PARK

24 September 2024

In a 9DASHLINE article in April 2024, I analysed the Japanese yen’s turbulence in the global economy, setting out the resulting challenges and opportunities for Japan. With the currency’s continued fluctuations in global currency markets, it is clear that economic volatility and geopolitical tension remain at the forefront.

From March to August 2024, the yen experienced a rollercoaster of fluctuations, reflecting the high sensitivity of currency markets to both domestic policy changes and global geopolitical events. Key drivers included Japan's shift away from its negative interest rate policy, interest rate hikes, and uncertainties surrounding a potential US recession. These fluctuations represent a “new normal” for the yen and explore its potential implications for the economic and geopolitical landscape in the Indo-Pacific region.

The yen's fluctuation from March to August

The core of the yen’s recent volatility is the Bank of Japan’s (BOJ) monetary policy. In March, the USD/JPY exchange rate ranged from a low of 146.92 to a high of 151.61, reflecting the yen’s depreciation. Such a weak yen prompted the BOJ, under the leadership of Kazuo Ueda, to intervene in April to stabilise the currency. The central bank in Tokyo ended its negative interest rate policy that has lasted for eight years, and increased interest rates for the first time in 17 years. Despite these policy changes, the yen continued to weaken, reaching its lowest point on 9 July (161.60 yen to 1 USD), since June 1986. Thus, the BOJ underwent another intervention on 11 July, spending up to 3.57 trillion yen (USD 30.11 billion) in the foreign exchange market to lift the yen from its 38-year low.

Beyond its borders, the yen’s fluctuations have sent ripples throughout the Indo-Pacific region. As regional economies are also influenced by the yen’s depreciation, the spectre of competitive devaluations looms large.

The exchange rate peaked at around 161.90 in July just before the yen appreciated significantly by over 12 per cent following the central bank’s rate hike. Throughout July to August, the yen moved from 161.99 on 3 July to 141.66 by 5 August. This appreciation was partly due to the BOJ’s decision to raise interest rates to 0.25 per cent and reduce bond purchases that strengthen the yen against the dollar. However, the yen’s rapid appreciation on 5 August triggered a massive sell-off in the Japanese stock market, with the Nikkei Stock Average plummeting 4,451.25 points, or 12 per cent, its worst-ever daily decline. This sell-off was driven by concerns over a potential US recession and the yen’s strength, which could negatively impact Japanese exporters. Surprisingly, the market rebounded sharply the day after, 6 August, surging 3,217.46 points, or 10.2 per cent. The rebound was attributed to strong US service sector data for July, which eased concerns about a recession and led to a correction in the dollar-yen rate that had moved excessively on the previous day. In August, the yen’s value again fluctuated between 143.89 and 149.34, with an average rate of 146.63. This volatility was due to the interest rate disparity between the United States and Japan, as well as market reactions to a potential US economic downturn.

The BOJ’s unwavering commitment to yield curve control and ultra-low interest rates has played a central role in guiding the yen’s value. Nevertheless, this accommodative stance has not been without its consequences. As Milton Friedman famously remarked, “Inflation is taxation without legislation”. The BOJ’s policies have fueled concerns about inflationary pressure, which has permeated Japan’s domestic economy and is evident in the recent surge in consumer prices, driven in part by rising food and energy costs. While the BOJ has maintained its position that the current inflation is largely transitory, there is growing concern that persistent price increases could erode consumer confidence, which fell 0.27 per cent from a year earlier and lead to a wage-price spiral. The BOJ faces a difficult balancing act as it seeks to stimulate economic growth while keeping inflation under control.

Geopolitical ripple effects in the Indo-Pacific

The yen’s depreciation has significantly impacted Japan's export-oriented industries, particularly in the technology and automotive sectors. In May, exports increased 11.9 per cent compared with the same period last year, the highest growth rate since November 2022. It was also evident in the mid-August Nikkei rally, where major exporters such as Tokyo Electron, Sony, and Toyota led the gains. The Nikkei Stock Average surged 3.5 per cent on 13 August, boosted by a weaker yen after the Bon holiday.

While the weaker yen has boosted Japan's export-oriented industries, it is crucial to recognise the double-edged nature of this currency depreciation. Many Japanese small and medium-sized enterprises, especially in manufacturing with high dependence on imported energy and raw materials, are facing significant challenges due to increased import costs. This internal economic strain highlights the mixed effect of the currency’s fluctuations. The benefits of a weak yen are not well distributed across the Japanese economy and may come at a considerable cost to certain sectors.

Beyond its borders, the yen’s fluctuations have sent ripples throughout the Indo-Pacific region. As regional economies are also influenced by the yen’s depreciation, the spectre of competitive devaluations looms large. The risk of a “race to the bottom” in currency markets threatens to increase trade tensions and hinder the delicate balance of regional economic cooperation. The prospect of a new Asian currency war, originating from the yen’s fragility, has been growing as South Korea and Taiwan are direct competitors to Japan in many industries. As in the 1997 East Asian Financial Crisis and the global financial crisis aftermath in 2009-2010, Asian countries have employed competitive devaluations and implemented strategic monetary policies to boost exports and protect their economies. Other nations in the region are also feeling the pressure to adjust their monetary policies in response. Adding to this complex currency landscape, China’s yuan reached a 31-year high against the yen on 17 April, and in response, Chinese policymakers shifted their focus from defending the yuan against depreciation to curbing its rapid appreciation. Beijing’s balancing act to jeopardise its currency further complicates the region’s monetary dynamics and suggests significant potential for escalating currency tensions.

As in the words of John Maynard Keynes, “the importance of money flows from it being a link between the present and the future”, Japan’s decisions will shape the nation’s future geopolitical standing. In the context of its defence spending and vulnerability to currency fluctuation, Japan faces a critical challenge that could jeopardise its ambitious defence spending plan. In April, Tokyo’s goal of increasing its military expenditure to 2 per cent of GDP over the next five years was under threat. The yen’s weakness against the dollar significantly reduced Japan’s purchasing power for military equipment, as about 60 per cent of the nation’s artillery is imported from the US. For the longer term, Japan may need to focus on fostering its domestic defence industry to reduce its procurement of arms from foreign suppliers. However, such a self-sufficient strategy faces significant hurdles: a shortage of skilled workforce, a limited domestic market, restrictions on international cooperation, and issues regarding technology transfers from US-based firms.

The financial implications of a weaker yen on Tokyo’s military spending could lead to several security ripple effects in the region. First, Japan may delay or reduce the scale of planned defence equipment acquisitions, directly impacting its military readiness and modernisation efforts. Second, if Tokyo struggles to maintain its defence capabilities, it may become more vulnerable to regional threats, especially from Moscow, Pyongyang, and a more militarily assertive Beijing. Third, budget constraints that force Japan to cut back on arms purchases could strain the US-Japan alliance. Such a situation may require a renegotiation of their security cooperation and the seeking of more cost-effective solutions — which is likely to affect the strategic balance within the alliance. Consequently, Japan might invest in areas like cybersecurity and other emerging and disruptive technologies (EDTs) as a more cost-effective alternative means to strengthen defence capabilities within budget limitations.

The new normal: long-term outlook

From the 1980s to the early 2000s, currency markets were more predictable, as they were driven largely by interest rate changes. Central banking traditionally relied on the interest rate steering (IRS) approach for economic stabilisation. In contrast, in this “new normal”, brought about by the aftermath of the 2008 global financial crisis, persistent low inflation, and the limitation of traditional monetary policies, central banks are more responsive to global economic conditions. They have adopted unconventional tools such as asset purchases, quantitative easing (QE), and until recently for Japan, negative interest rates to provide additional stimulus when conventional interest rate cuts are no longer effective. Central banks have been compelled to attempt these unconventional measures by the ineffectiveness of traditional interest rate adjustments in reviving economies. The yen’s fluctuation is an example of this new volatility. Although these monetary policies aim to stabilise the economy, they may lead to significant currency fluctuations due to shifts in investor expectations and capital flows, causing the yen to swing from historic lows to sharp appreciations within months. Currency values are increasingly affected by geopolitical developments, climate-related risks, and technology changes which lead to more unpredictable market movements. Such new challenges to balance domestic economic needs with global financial conditions are evidenced by Japan’s recent shift away from negative interest rates and active intervention amidst persistent yen instability.

DISCLAIMER: All views expressed are those of the writer and do not necessarily represent that of the 9DASHLINE.com platform.

Author biography

Seohee Park, PhD is a postdoctoral research fellow at the Department of International Politics and Economy, Graduate School of International Cultural Studies, Tohoku University. She is also a lecturer at the College of Asia Pacific Studies, Ritsumeikan Asia Pacific University. Image credit: Image credit: Rawpixel.com/Freepik.