Japan's Yen Crisis Explained: Why the Currency Is Plunging and What It Means
What is happening to the yen
The Japanese yen has been weakening against the US dollar for several years, falling to levels not seen since the 1990s. The decline has been severe enough to trigger repeated government intervention, with the Bank of Japan and Ministry of Finance spending billions buying yen to support the currency, only to see the falls resume once the intervention stops.
A weak yen sounds almost theoretical until you experience its effects. In Japan, imported goods become more expensive, squeezing household budgets. For tourists, Japan has become dramatically cheaper, boosting tourism but inflating local prices in popular destinations. For global investors and other central banks, a yen collapse is a risk event with wide potential consequences, from currency-market volatility to knock-on effects in emerging markets.
Why the yen is falling
The fundamental driver is the gap between Japanese and US interest rates. Central banks set the price of money in their currency. When a country's interest rates are much lower than another's, investors borrow the cheap currency, convert it to the high-rate one, and earn the difference. This carry trade creates constant selling pressure on the low-rate currency.
For years the Bank of Japan kept interest rates below zero or at rock bottom, trying to stimulate an economy that struggled with deflation since the 1990s. Meanwhile, the US Federal Reserve raised rates aggressively to fight post-pandemic inflation. The interest-rate gap between the two widened to historic levels. Money flowed out of the yen and into the dollar. The yen fell.
Compounding this is Japan's structural trade position. Historically a powerhouse exporter, Japan has run trade deficits in recent years, partly because it imports almost all of its energy and food, both of which became more expensive in yen terms as the currency weakened. A vicious cycle takes hold: the yen falls, imports cost more, the trade deficit widens, and the additional yen selling pressure pushes the currency down further.
Why intervention is not working
When the Bank of Japan intervenes, it buys yen and sells dollars, temporarily pushing the price up. But unless intervention is accompanied by a change in the underlying interest-rate gap, markets tend to fade the effect within days. Traders know that the central bank cannot sustain intervention indefinitely, and they test the defence repeatedly.
A more durable fix would be for the Bank of Japan to raise interest rates, narrowing the gap with the US. But doing so is extraordinarily painful domestically. Japan carries one of the highest levels of public debt relative to GDP in the developed world, and much of that debt is held domestically. Higher rates sharply increase the government's interest costs, straining fiscal budgets. Japanese households and companies are also not accustomed to high borrowing costs, and abruptly normalising rates risks choking off a fragile domestic recovery.
Global implications
A yen collapse is not just a Japanese problem. The yen is one of the world's most traded currencies and a linchpin of global carry trades. If yen weakness accelerates, investors who borrowed yen to buy higher-yielding assets elsewhere may be forced to unwind those trades, causing volatility across emerging markets and risk assets globally.
A weaker yen also puts competitive pressure on exporters in neighbouring countries, especially South Korea and Taiwan. Their goods become relatively more expensive on world markets, squeezing margins and potentially accelerating trade frictions. The political rhetoric around currency manipulation, dormant for several years, has begun to resurface.
Japan's allies are watching carefully. A deeper yen sell-off could force coordinated intervention by major central banks, a rare event reserved for moments of acute stress. For now the hope is that jawboning, modest intervention, and the gradual narrowing of the rate gap will stabilise the currency without a more dramatic crisis. Whether that hope is well-founded will be one of the most consequential financial questions of the coming year.
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