Musha Research Commentary

15November 2023

S\Strategy
Bulletin (No. 344)

Enjoy the Weak Yen!
～The weak yen will ensure a dramatic revival of Japan'smanufacturing industry.
Rampant arguments for Japan's failure
The yen has plunged, with the dollar at 151.6 yen, the weakest in almost 33 years since 1990.
The decline in the yen's real effective exchange rate (2020=100), which indicates the strengthof a currency, has been even more extreme, falling to a historic low of 72.4 as of the end of
September 2023, a 13% depreciation compared to 83.6 during the Smithsonian era (19711973), when the dollar was 308 yen to the dollar. Bad yen theory began to be discussed in
the media and among economists. The Sankei Shimbun reported that Japan's nominal GDP
is expected to fall to fourth place in the world, overtaken by Germany and India. The Nikkei,in an article full of self-mockery, called this an era of yen weakness, citing Japan's weaknesses
that cause the yen to weaken. It interprets the yen's weakness as an argument that capitalwill flee Japan's weak growth potential and cause the yen to weaken. However, Japan's low
growth potential is not a new story; since 2010, when the yen has been strong, massive
amounts of capital have flowed out of Japan to other countries with high growth rates, yet theyen has remained strong. The argument that the yen is weakening because Japan is failingdoes not hold water.

Figure 1: Real Effective Rate of the Yen200(2020=100)

194.0

190

(1995/4)

180
170
160
150
140

130
120
110
100
90
80

72.4

83.6

(2023/9)(1972/1)

7072 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22
Source: Bloomberg MushaResearch

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Musha Research Co., Ltd.
President
Ryoji Musha
musha@musha.co.jp
http://www.musha.co.jp
Tel ＋81-3- 3740 2143
2-16-7-3912, Konan,Minato-ku, Tokyo
108-0075,Japan

315 November 2023
Interest Rate Differential Hypothesis and Current Account Balance Hypothesis Cannot
Explain Yen Weakness
Strategy Bulletin vol344

There is a theory that yen carry trade is increasing due to the interest rate differential. Japan, with the world's lowest
interest rates, is certainly attractive as a funding currency, especially with the rapid rise of interest rates in Europe,including Germany, which until two years ago had negative interest rates below Japan's. However, the carry trade canresult in a significant foreign exchange loss when the yen appreciates: if one were to borrow $1 at ¥150 per dollar andrepay it at ¥100 per dollar, one would need to borrow $1.5 to repay ¥150. At a time when the yen is at 151 yen per
dollar, the weakest it has been in 33 years since 1990, are people betting on a further depreciation of the yen? If so, it
is a significant gamble. To begin with, the yen has been weakening even as the Japan-U.S. interest rate differential hasbeen narrowing over the past few days. The yen has been weakening not only against the dollar, but against almost all
currencies. The yen has weakened even against the Chinese yuan, which has been cutting interest rates, and the South
Korean won, which has been retreating from its hawkish stance.

Figure 2: Japan-U.S. Long-Term Interest Rate Differential and the Yen-U.S. Dollar Exchange Rate
10160

98Yen-US dollar rate

140

76120
541003FF rate

280

Japan-U.S. long-term interest rate differential
1060
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23
Source:Bloomberg ,Musha Research

Figure 3: Trends in the Yen against Major Currencies (January 2007=100)
45 (2007Jan＝100)
50
55
60
65
Yen Appreciation
70
75
80
85
90
95
100
105
110
Yen Depreciation
115
120
125
130
135
07
08
09
101112
Source:Bloomberg ,Musha Research

Korean Won

EuroUSD
Taiwan dollar

Chinese Yuan

131415

16

2/5

1718

1920

212223Musha Research.

15 November 2023

Strategy Bulletin vol344

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Yen depreciation beyond the BOJ's defenses
We are beginning to see comments calling for something to be done about this unidentified depreciation of the yen. If
the strong yen is the source of the soaring prices that are depriving people of real income, the BOJ must turn to monetary
tightening. BOJ's Ueda probably took a preemptive action against critics of the yen's depreciation. He surprised themarket by recalibrating the YCC (allowing the upper limit of long-term interest rates to break through the 1% mark) at
the end of October, following the end of July, but this came up empty. Since the foreign exchange market no longer
responds to a narrowing of the interest rate differential, it must be said that the current depreciation of the yen has
exceeded the BOJ's defenses.
Figure 4 shows the return on 10-year U.S. government bond investments with currency hedging and shows thatJapanese investors have been losing more than 1% for more than a year due to hedging costs that significantly exceed
the interest rate difference when hedging against the dollar. Chart 5 shows the dollar hedging cost of the yen and theeuro. Since the latter half of 2022, the hedging cost of the Japanese yen has risen to an extremely elevated level of 6%.
The two had been in tandem until then, but they have diverged significantly, with a 4% gap in the latest figures. Since
the hedging costs can be explained as the mirror of market general expectation, market participants have suddenly
become very bearish towards Japanese yen.

Figure 4: Currency Hedged U.S. Government Bond Investment Returns, Yen Returns and EuroReturns
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5

(%)

2017

JPY hedged US 10-yr treasury yield
EUR hedged US 10-yr treasury yield
Japan 10-yr treasury yield
German 10-yr treasury yield

2018

2019

2020

2021

2022

2023

*Adjusted for 3-month hedging cost
Source: Bloomberg, Musha Research

Figure5: Hedging costs of the yen and euro against the U.S. dollar
7Hedging costs of the yen against the U.S. dollar

654
3210
2017/1Hedging costs of euro
against the U.S. dollar
2018/1

2019/1

Source:Bloomberg Musharesearch

2020/12021/1

3/5

2022/12023/1

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15 November 2023
The true nature of the yen's depreciation, geopolitics, invisible to market participants
Strategy Bulletin vol344

The yen is now being perceived as undervalued for reasons other than interest rate differentials, economic strength,
the trade balance, or the capital account balance. Where does this view of the yen's future depreciation come from? Itis the will of the U.S. authorities, as Japan (with the fifth largest trade surplus with the U.S.) was once again removed
from the U.S. Treasury Department's foreign exchange watch list (China, Germany, Malaysia, Singapore, Taiwan, andVietnam) in November. One cannot help but think that the super depreciation of the yen is a means of implementing
the national strategy of the hegemonic US, which has no choice but to relocate its industrial clusters of high-tech
manufacturing industries, which are concentrated in the geopolitical danger zones of China, Taiwan, and South Korea,
to the safety of Japan. Treasurer Kanda and Treasury Secretary Yellen are on the same page, saying, "The level itself
is not the determining factor, but volatility is the issue.

The exchange rate does not project economic reality, but rather creates economic reality.
Market participants and economists alike must reverse the cause-and-effect relationship regarding exchange rates.
They must know that exchange rates are not the result of economic realities, but the cause of them. In the past, many
economists argued that Japan should accept the reality of a strong yen because deflation was strengthening thepurchasing power of the yen. However, the appreciation of the yen has eroded Japan's competitiveness, encouraging
the outflow of companies, business opportunities, jobs, and capital overseas, and has hurt Japan's domestic demand,
which in turn has caused further deflation. The vicious cycle of a strong yen and deflation was broken by Abenomics
and Kuroda's other-dimensional easing, which attempted to achieve reflation by inducing a weaker yen as a starting
point.
We should not forget that the exchange rate is one of the most important indicators that will determine the futureeconomy. The U.S., eager for Japan's industrial revival, is inducing the yen to weaken. As South Korea dramaticallystrengthened its competitiveness and knocked out Japan's high-tech firms during the remarkable depreciation of thewon from 2008 to 2013, the persistent depreciation of the yen will prepare Japan for a dramatic reemergence. Japan
will re-emerge as a manufacturing powerhouse and a services (tourism) powerhouse. This will revive Japan's strong
yen over the long term. Japan should take advantage of the fortuitous depreciation of the yen and should not waste itstime in trying to induce the yen to appreciate.

Figure 6: U.S. Treasury Department's Major Trading Partner Surveillance Indicators© Copyright 2023 Musha Research Co., Ltd. Although the information contained herein is based on sources that Musha Research believe reliable, Musha Research do not make any representation orwarranty, express or implied, with respect to the fairness, correctness, accuracy, reasonableness or completeness of the information and opinion herein. Musha Research is not responsible for any losses
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