Musha Research Commentary

14 July 2024

S\Strategy
Bulletin (No. 358)

We cannot overlook the “weak yen is bad” theory
Do not break the back of Japan's economic revival!
The yen continues to weaken. Consumers, the Japan Chamber of Commerce andIndustry (JCCI) and other business organizations that represent small and medium-sizedbusinesses, as well as many economists, are voicing their concerns and criticisms.
Should we view this the “weak yen is bad” theory as a good thing or a terrible thing? Thereason we cannot ignore this issue is that it is strongly linked to policy choices andJapan's future directions.

A weak yen is an income transfer from buyers to suppliers, but only
temporary
The exchange rate debate is quite simple. It is all about the conflicting effects of a weakeryen: (1) positive for those who export (= those who receive yen and make money) and(2) negative for those who import (= those who pay yen and spend money). But thatconflict confuses the situation. Criticism of the weak yen is developed from the standpointof the latter. The weak yen is a problem because it raises import prices, depriving peopleof real income. Since 2022, the rise in energy prices associated with the war in Ukraine
and the disruption of supply chains caused by the Corona pandemic have triggered global
inflation, while in Japan the simultaneous depreciation of the yen has pushed up prices
even higher. The government and the BOJ, which had targeted a 2% inflation, were able
to achieve their goal, even if only temporarily, but because it was not accompanied byhigher wages, workers' real wages fell sharply, depressing consumption. In addition,companies that depend on overseas production and imports saw their import costs rise,
putting pressure on their profits. However, these are short-term and transitory negativeeffects. Price increases will disappear when the yen stops weakening and the year-onyear change becomes zero.

Figure 1:

From punitive strong yen to beneficial weak yen

360

Spot Rate
310

Beneficial weak yen
Spot rate < PPP

260
210

PPP(Perchsing Power Parity)

160
Domestic-foreign
price differentials

110

Inverted
Domestic-foreign
price differentials

60

66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 11 14 17 20 23 26 29 32
Source: OECD, Musha Research

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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

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14July 2024

Hard-to-see benefits of a weaker yen

On the other hand, the benefits of a weaker yen, which stand on the former side, appear only gradually andare not uniform. If all companies were simply exporting dollar-denominated goods, the benefits of a weakeryen would be immediately linked to higher profits due to increased sales in yen terms resulting from foreignexchange gains. However, if exporters reduce the price of dollar-denominated exports by taking advantageof the weaker yen, the benefits of a weaker yen will not appear until the company's market share increases(i.e., sales volume increases) due to the price reductions. On the other hand, for companies exporting inyen, the benefits of a weaker yen will not be realized until the export price in yen is raised. For companies
that have moved their factories overseas, a weaker yen will increase the cost of imports from overseas
factories, which in turn will increase costs. Although there is the benefit of increased value when foreign
currency-denominated profits earned by overseas subsidiaries are converted into yen, this benefit will be
realized gradually over time. Furthermore, large global corporations, which are most likely to benefit from aweaker yen, do not speak loudly about the benefits of a weaker yen. Thus, while the disadvantages of a
weak yen are clear, the advantages are extremely vague and difficult to see. This is why the “weak yen isbad” theory tends to prevail in the media and in the economic discourse.

A weak yen attracts global demand to JapanThe most essential truth, however, is that demand, like water, leaves expensive areas and concentrates incheap areas. The depreciation of the yen has made Japan's labor costs, land, agricultural products, andfactory products significantly cheaper, making companies in Japan significantly more price competitive.
Companies that once moved their factories to cheaper overseas locations are beginning to bring them backto Japan. Whether entrepreneurs or individual tourists, consumers of products around the world are flocking
to Japan for cheaper prices, boosting domestic demand in Japan. This movement will increase capital
investment, production, employment, and wages, creating a virtuous economic cycle.

Economists ignorant of the volume growth and inflationary pressures caused by theweak yen
Even highly respected economists are often ignorant of two basics of exchange rate economics. The first is
the J-curve effect. In the initial stages of the yen's depreciation, the negative effect of a decline in real income
becomes apparent all at once. However, as time passes, the negative effects disappear, and a virtuous cycleof growth in production volume, capital investment, productivity growth, and wage growth continue over thelong term. The second ignorance is that exchange rates do not reflect the real economy but cause it to shape
future competitive conditions and the international division of labor. The United States, as the hegemonic
power, induced the super-strong yen to weaken Japan, which had been extremely competitive 30 years ago,
and as intended, the Japanese high-tech industry, which had been so strong, declined, and the industrial
cluster in Japan moved to East Asian countries such as South Korea, Taiwan, and China. As Japan became
the world's most expensive country, factories, jobs, and capital flowed out of the country, hollowing out
Japanese industry. In addition, wages, and land prices, which had become abnormally high by world
standards, came under enormous downward pressure, entrenching long-term deflation.

The weak yen has already created a huge pool of purchasing power (corporate profits
and tax revenues have surged).
The ongoing depreciation of the yen, contrary to the past 30 years, will cause Japanese companies tobecome more competitive and provide the basis for Japan's resurgence as an industrial powerhouse. The
weak yen and inflation (i.e., higher nominal economic growth) have already boosted corporate profits, stock
prices, and tax revenues significantly: corporate recuring income in FY2023 recorded 108 trillion yen (2.5times higher than 10 years ago), tax revenues 72.1 trillion yen (1.6 times higher than 10 years ago),
accumulated investment gain of the GPIF 153.8 trillion yen (4.3 times higher than 10 years ago), and TSE
equity capitalization of ¥1004 trillion (3.3 times that of 10 years ago). This has led to record capital investment
growth expected in 2023 and a 5.08% wage increase for the first time in 34 years, creating a huge pool ofpurchasing power. It is almost clear that Japan is entering an era of higher potential growth, a rarity among
advanced economies. The "weak yen is bad” theory will be completely debunked by the facts.

Increased tax revenues from a weaker yen should be passed on to consumers
Certainly, at this point, there is a need to bail out individuals who continue to suffer the disadvantages of theweak yen and have not yet entered the wave of prosperity, but the prescription is clear. The public finances
enriched by inflation should return money to the people whose wealth has been stolen by inflation in theform of permanent tax cuts.

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Figure 2:

14July 2024

Economic Indicator Before & After Abenomix and Pandemic

The elasticity of tax revenue, which indicates how much tax revenue grows compare with the nominal
economic growth, is abnormally high in Japan, ranging from 2.6 to 3.6 whereas ordinary country ranging 1.0
to 1.2. This is because Japan has continued to raise taxes in real terms by increasing the consumption tax
and social insurance premiums. This is discussed in detail in Yutaka Harada's recent book, "The Only Way
to Raise Japanese Wages" (PHP Research Institute).

Figure 3: Japan's Elasticity of Tax Revenue

Source: Yutaka Harada: The only way to raise Japanese wages

This is why tax revenues have increased significantly due to the inflation that has unexpectedly occurred.
The Ministry of Finance has been busy trying to hide the increase in tax revenues, since it is now likely tobe able to achieve a primary balance surplus in FY2025 without raising taxes. Multiplying the 5.7% increasein nominal GDP by the tax revenue elasticity of Mr. Harada's calculation yields a tax revenue increase of 10trillion yen, even using the lower limit of 2.6. It is believed that technical factors that reduce tax revenues,
such as changes in the tax payment method for consolidated companies, have been developed to suppress
surface tax revenues. The budget surplus has increased due to unspent budget funds and increased tax
revenues, which resulted in increase the Government Debt Consolidation Fund.

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Strategy Bulletin vol3568

Furthermore, in addition to increased inflationary tax revenues, the government has tens of trillions of yen
in foreign exchange gains from its $1.2 trillion holdings of U.S. government bonds, which are stored as"reserves. The depreciation of the yen and inflation have made Japan's fiscal policy remarkably powerful.

The Hidden Cause of the Weakening Yen: Fiscal Austerity
The dollar/yen rate is expected to peak around 160 yen due to the narrowing Japan-U.S. interest rate
differential and Japan's growing current account surplus. If the yen weakens and overshoots its peak, thegovernment could launch a policy mix of massive fiscal stimulus and monetary tightening, which would
quickly turn the yen's trend to appreciation. There is no need to worry about the yen weakening.
Based on the economic hypothesis (Mandel-Fleming Model) that expansionary fiscal policy and tightmonetary policy lead to a strong currency, while a tight fiscal policy and loose monetary policy lead to a weakcurrency, the US has a typical strong currency policy mix and Japan has a typical weak currency policy mix.
Japan, with its strong hidden fiscal power, can easily stop the depreciation of its currency by creating a highpressure economy through fiscal stimulus.
Figure 4: Tax elasticity of Major Countries

FRANCECANADA

UKJAPANGERMANY
ITALYGREECEUSSource: Yutaka Harada: The only way to raise Japanese wages© 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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