Japan has been in an economic funk since the 1990s. It was at that time that many speculated it would overtake the U.S. as the global economic superpower rather than China. However, a poorly regulated financial system led to a housing crisis, from which they have yet to recover.
With the recent election of Shinzo Abe as Prime Minister and his appointment of Haruhiko Kuroda as governor of the Bank of Japan, the government has embarked on an extremely aggressive approach that involved significantly devaluing their currency.
It sounds odd that Japan would purposely devalue the yen, but it makes sense when considering the extent of their dependence on exports. Consumers value goods that are inexpensive, making the yen depreciation beneficial. When the value of the yen declines relative to a foreign currency, then that good will become more affordable to foreigners.
For instance, a weaker yen drives the price lower for a Nissan car, thus making it more attractive than a GM car to Americans. This will lead to more Nissan cars and fewer General Motors cars being produced. Therefore, this has the effect of boosting employment in Japan’s auto industry, but lowering employment in the U.S.’ auto industry.
Even though this is potentially damaging to the U.S. economy, it makes Europe and developing countries even more vulnerable. While the U.S. has a strong internal economy and is not as dependent on exports, that is not the case for emerging countries in Asia, South America, Africa and parts of Europe. A weaker yen places more pressure on those countries because their goods are now more expensive. They are faced with two unenviable options: Either accept that their currencies will rise and cause unemployment to rise or also devalue their currencies and risk higher inflation.
Theoretically, Japan is more able to absorb a weaker currency than most countries because its citizens historically have high saving rates. Even though a weaker currency typically drives people to buy more goods and allow businesses to drive up prices, that might not be the case in Japan where buyers are typically frugal in their purchases. This is one of the reasons why Japan has been plagued with deflation despite significant monetary and fiscal expansion. On the other hand, it could benefit Japan through increased employment opportunities due to more goods being sold abroad.
However, there is a downside to this strategy. Bond investors are already leery about Japan’s excessive debt levels that actually dwarf the U.S. The danger is that bond investors will flee Japan, which would drive their interest rates higher. If this occurs, then that will make it more difficult for Japanese businesses to gain access to cheap credit and could depress future economic growth.
Even though these events are taking place across the Pacific, the ramifications of a weak yen are potentially huge. It could lead to a currency war that could result in higher global inflation and create more economic turmoil worldwide. A slowly growing global economy means fewer opportunities for Americans, who are becoming more reliant on exports to increase employment and boost their standard of living.
Aaron Johnson is the Assistant Professor of Economics at Darton College in Albany, GA, USA. In addition to his teaching duties, he is a board member for the Albany Dougherty Economic Development Commission and the Albany Dougherty Planning Commission. He also publishes a blog on economic issues. His pieces have been published with the Atlanta Journal-Constitution, Albany Herald and various regional publications.