Why is the Yen falling?

The sharp depreciation of the yen since last fall has become a matter of concern for China, which has developed strong economic ties with Japan through trade and investment. While there is no consensus as to why the yen is weakening, the following four interpretations are typical.

The first view sees the weakening yen as a reflection of Japan's lackluster economic performance -- the vulnerability of its financial system, protracted economic stagnation, and a shrinking trade surplus -- and the incompetence on the part of the government to improve the situation. This view finds credence in the repeated pronouncements by Japan's monetary authorities that "the yen rate reflects the fundamentals of the Japanese economy" and that "the yen is at an appropriate level."

The second view emphasizes Japan's irresponsibility. By assuming a laissez-faire attitude toward the yen's depreciation, Japan is embarking upon a beggar-thy-neighbor policy that may lead to a second Asian currency crisis. Underscoring this view is the judgment that if Japan wanted to act to stabilize the yen, it could, given its status as the world's largest creditor country and second largest economy. In particular, Japan's foreign exchange reserves amounting to over $400 billion should give its monetary authorities a leverage to exert considerable influence on foreign exchange markets. These facts notwithstanding, Japanese officials have not only remained mute about taking any actions to stop the yen's slide, but have also repeatedly stated that they will tacitly permit a further depreciation.

The third view is that the yen's depreciation is a short-term tactic to boost the Japanese economy in order to buy time and to ease the pain of structural reforms. A weaker yen is expected to expand exports by enhancing the price competitiveness of Japanese products, to mitigate deflation through raising the prices of imports, and to inflate the yen value of Japan's overseas securities holdings (which are mainly denominated in dollars). The news that the government is considering measures to induce the yen to fall through the purchasing of foreign bonds seem to support this view.

The fourth view looks at the yen's depreciation as a long-term strategy on the part of Japan to contain China. It postulates that the current round of yen depreciation is timed with China's entry into the WTO and that the true objective is to discourage foreign investment in China by destabilizing the renminbi, thus weakening China's international competitiveness and attractiveness as an investment destination. The yen's depreciation is a strategy that aims particularly at stopping the hollowing out of Japan's hi-tech industrial sector, which may accelerate as leading corporations shift their manufacturing bases to China to reduce production costs.

Among these four interpretations, the majority view in Japan favors "incompetence" over "irresponsibility" and "tactic" over "strategy," while the perception in China is precisely the opposite. Thus the public opinion in China is dominated by the "irresponsibility" and the "strategy" interpretations, reflecting a deep-rooted distrust of Japanese intentions. It should, however, be noted that such conspiracy theories are based on the unrealistic assumptions that the Japanese economy is basically in good shape, and that the Japanese government has both the will and ability to formulate and to implement a grand strategy in line with the country's national interests.