The Japanese Government Is Right to Defend the Yen (Part 2)

More details on Japanese financial positions and the state of yield curve control.

Japan’s Ministry of Finance (MoF) sold about $63 billion in foreign exchange reserves in September and October to preserve the yen’s international purchasing power.

It should continue to do so.

Temporary factors—particularly the pandemic-related shortfall of tourism revenues and war-related commodity price spikes—are depressing the value of the yen below where it would reasonably be given the country’s underlying economic fundamentals. Japan has a structural current account surplus, attractive relative real growth prospects (at least cyclically), minimal inflation, and (relatively) high interest rates relative to nominal income growth. Yet the yen has depreciated more than almost every other currency relative to its trading partners. These are precisely the conditions when it makes sense to use ample reserve holdings accumulated in the past to bridge the gap between national income and national spending.

Crucially, the Japanese government has the necessary resources at its disposal to do what it takes. The country’s reserves aren’t limitless, but the MoF could continue intervening at the current rate for years, if necessary. The Government Pension Investment Fund (GPIF) could also hedge the exchange rate risk of its portfolio of more than $700 billion in foreign stocks and bonds.¹

In my previous note, I looked at why the yen had come under pressure, as well as the unique domestic conditions that explain why the Bank of Japan (BOJ) has so far refused to join central banks in the rest of the world in their campaigns to slow growth by raising short-term interest rates. In this note, I will focus on the details of Japanese macroeconomic balance sheets and the sustainability of the BOJ’s program of yield curve control.

Japan’s Financial Fortress

As of mid-2022, Japanese residents owned about $10.5 trillion in foreign assets while foreign investments in Japan were worth about $7 trillion. Japanese obligations to foreigners mostly take the form of low-yielding yen-denominated loans, deposits, and bonds. By contrast, Japanese businesses have a net foreign direct investment position worth about $1.7 trillion and Japan’s Ministry of Finance held about $1.1 trillion in reserve assets before the most recent interventions.

Japan’s net foreign asset position generates substantial income for Japanese residents, currently worth almost 5% of Japanese gross domestic product. Moreover, the composition of assets and liabilities guarantees that net income from abroad rises whenever the yen depreciates and whenever interest rate differentials widen with the rest of the world, which is why the income surplus relative to GDP is about 1 percentage point higher today than it was in the years before the pandemic.

This is a valuable hedge. In the six months from March 2022 through August 2022 (latest monthly data available), net foreign income for all Japanese residents was worth about $120 billion. That’s up from $100 billion in March-August 2021, and even eclipses the previous high of $110 billion in March-August 2019. For perspective, Japan’s trade deficit in goods and services in March-August 2022 was $84 billion.