Japanese yen continues to slide

The Japanese yen is making waves on Twitter (X) and financial papers as the currency continues to languish at a 34-year low against the dollar. I thought I'd go into a little background into what's happening and why it's important for international markets. Japan has been caught in an economic quagmire for over three decades due to expansionary monetary policies and excessive debt accumulation. The root of the problem traces back to the early 1990s when the country experienced an asset bubble burst, leaving behind worthless assets but substantial loans that needed to be repaid. To revive the economy, the Bank of Japan (BOJ) adopted a zero or negative interest rate policy and began printing money out of thin air through quantitative easing measures. This allowed the government to borrow extensively without worrying about repayment costs. The government's debt level ballooned to over 260% of GDP, an unsustainable burden. The BOJ's easy money policies facilitated a massive yen carry trade, where investors borrowed cheaply in yen and invested the proceeds in higher-yielding foreign assets like U.S. Treasuries. This carry trade is estimated to have reached over $1 trillion in scale. However, as the yen kept depreciating due to Japan's debt-driven monetary policies, the brokers facilitating the carry trades demanded more collateral from investors to hedge their currency risk exposure. This forced investors to borrow even more yen from the BOJ to obtain the collateral, exacerbating the yen's devaluation in a vicious feedback loop. Now, Japan finds itself stuck in this 'doom loop'. Raising interest rates will increase the government's debt servicing costs, necessitating more debt issuance and money printing by the BOJ to repay creditors. But this further devalues the yen, triggering more collateral calls on the carry trades and intensifying the loop. The unwinding of the bloated carry trades also risks deflating asset bubbles in foreign markets that were inflated by the invested yen proceeds over decades. One circuit breaker for this doom loop would be lower US yields/weaker US macro environment, but the large problem is that the BOJ's main tools for tackling the Yen's weakness will indirectly add upward pressure to global yields. They're stuck between a rock and a hard place, and speculators know it. With economic prospects unclear, Japan faces tough choices and no easy way out of this prolonged monetary predicament.

By Charlie Ormond

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Japanese yen continues to slide

By Charlie Ormond

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