30 years of the zombie economy: Japan’s currency crisis gathers momentum

It is a decades-long process centered on Japan’s decision to try to keep alive companies and banks that were threatened with bankruptcy in the crash of the late 1980s at all costs. Keeping these zombified companies alive led to a 20-year decline in the country’s stock market, and the highs reached in 1989 were only surpassed in February of this year (35 years later).

The crash that followed the boom of the 80s, which started with excessive debt, was covered by even more loans. This brought Japan’s national debt level to the absolute top among countries in the world. Now that the yen is falling rapidly, the country has only two bad choices on the table – let the North’s government and the entire debt-based system fall, or let the Yen fall. It seems that the country has chosen the path of lowering the yen, which is also reflected in the drop in the exchange rate.

One dollar traded at 161.6 yen on July 3, the lowest level since 1986. The yen has therefore not traded at such a low level for 38 years.

Such falls in the exchange rate can become self-sustaining processes, fueled simply by traders selling the yen. When the yen falls, no one wants to hold it, which in turn creates further selling pressure. This could lead to the free fall of the currency, which we saw with several currencies during the 1997 Asian financial crisis.

The government is ready to intervene in the currency market

The Japanese authorities have promised to take the necessary steps to ensure the stability of the currency. The country’s finance minister, Shunichi Suzuki, said at the end of June that they are ready to intervene in the currency market.

“We want exchange rates to move stably. We do not want sudden and one-way movements. We are very concerned about how this will affect the economy,” Suzuki told reporters. “We monitor the movements very closely and take action if necessary.”

Japan is highly dependent on imports for both food and energy. As the yen depreciates, these vital import items become more expensive, potentially fueling price hikes in the country. The central bank has the tools to fight high inflation, but its hands are tied due to the huge public and private debt burden. It is not recommended to bankrupt the country.

This year, the yen has already depreciated by nearly 14 percent against the dollar. The yen’s faster decline against the dollar started already at the beginning of 2022. In just over two years, the yen has fallen 40 percent against the dollar. Let’s take a look at the price of gold in yen, which has started to grow very quickly in recent years:

The previous major decline in the yen took place at the end of April this year. Then the central bank also intervened in the market, buying yen for 61 billion dollars to support the exchange rate. While this initially caused the yen to strengthen again, as the days passed, the currency fell to new lows again.

Foreign investors are fleeing the country

Investors are mainly focused on the fact that the Bank of Japan has not continued to raise interest rates despite accelerating inflation. While the base interest rates in the USA and Europe are 5.5 and 4.25 percent, respectively, the base interest rate in Japan continues to be 0.1 percent. Whereas Japan started lowering interest rates in the 90s and has not raised them significantly until now. And it is very difficult for them to do so because of the high debt burden.

International capital tends to flow to countries with higher interest rates. Of course, the movement of capital also depends on other factors – political stability, regulations and the economic environment. Since no income is earned by investing in bonds denominated in yen, it is not recommended to invest money there. Essentially, only the local central bank and local investors remain in the yen-denominated bond market.

According to analysts, intervention in the currency market may not work, and the yen will fall like an avalanche, which will be very difficult to stop. Although inflation in Japan has been lower than in Western countries over the past decade, the rapid depreciation of the currency threatens to fuel price increases.

Interest cannot be increased due to the debt burden

To avoid this, the central bank can raise interest rates, which would help reduce the country’s currency stock and support the exchange rate. The central bank has also talked about possibly raising interest rates, but there is one big problem with that – the Japanese government has a huge debt burden, which would become very difficult or even impossible to service at significantly higher interest rates.

It is already predicted that the government’s interest payments on the national debt will double over the next decade. In this case, however, it is assumed that the interest on the national debt will rise only minimally.

Japan’s public debt burden reaches more than 260 percent of GDP. With this, according to the IMF, the country is the country with the largest debt burden in the world. It has not caused a very big economic collapse, but living in debt has had a very high price, the bigger consequences of which are only now beginning to appear for the yen.

Japan reached this point as a result of a process lasting several decades. It all started already in the late 1980s, when Japan’s economy was booming with the support of exports. Since the central bank wanted to keep exports viable, interest rates were lowered – otherwise, the foreign trade surplus would have led to a rapid strengthening of the yen, which in turn would have put pressure on exports.

Huge credit expansion

Low interest rates led to credit expansion – as is typical of a debt-based monetary system. This led to a boom in real estate and the stock market, all of which burst with a bang in the late 80s. It can be said that the Japanese Nikkei stock index reached its absolute bottom only during the 2009 financial crisis, having been in a downward trend for 20 years. The stock market there did not surpass the 1989 peaks until February of that year.

Interest rates have been kept extremely low for decades in order to manage the large debt burden and to continuously stimulate the economy. 2016 also saw the start of controlling interest rates on national debt – meaning that interest rates on long-term bonds were not allowed to rise above 1 percent, which meant that the central bank bought massive amounts of national debt to meet this goal.

Now, however, this is becoming a big problem, because both Europe and the USA have gone the way of raising interest rates. Since capital usually flows from countries with lower interest rates to countries with higher interest rates (provided that the risks are more or less the same), capital is fleeing Japan.

Since the Central Bank of Japan does not have much room to raise interest rates, as this would lead to problems in the repayment of the national debt, a further decline of the yen can probably be expected. The exodus of Japanese into other countries’ assets (currencies, stocks) may gain momentum, and this in turn will lead to an even faster depreciation of the yen. Already, there is a trend where exporters do not want to convert their earnings in euros and dollars into yen, which gives further momentum to the decline of the yen.

This could escalate into a serious currency crisis spanning the entire Asian region, involving other Asian countries that are closely linked to Japan and whose currencies could come under attack by speculators. Since many other Asian countries have taken out large amounts of dollar-denominated loans, a fall in exchange rates could have a devastating effect on those countries, making it extremely difficult to service foreign currency debt.