Japan: Struggling to Weaken the Yen

Published on February 23, 2018

Persistent strength in the Japanese Yen, especially vis a vis the US Dollar, has been frustrating the reflationists among Japan’s economic policymakers, all the more so coming on the heels of Prime Minster Shinzo Abe’s reappointment of Haruhiko Kuroda to a rare second term as Governor of the Bank of Japan. In addition, dovish Deputy Governor Kikuo Iwata will be swapped out for a lesser known, but equally reflationist, ally in Masazumi Wakatabe, but to no avail either on the strengthening yen.

That frustration led Koichi Hamada, the influential professor, advisor, and confidante to Prime Minister Abe, to suggest in a wire service interview that Kuroda should consider expanding BOJ asset purchases to include the purchase of foreign bonds. That would mean a massive, and extremely controversial, shift in BOJ policy to include the large-scale purchases of US Treasuries in its program.

** The discussion over the BOJ potentially purchasing foreign securities (mainly bonds, not foreign equities) is not new to Japanese economic circles. Hamada himself was on the record mulling that option in an interview with a domestic magazine in 2016, although he also pointed out then, as he does now, potential objections from the US to what may be construed, quite rightly if truth be told, as FX intervention under the cover of the pursuit of domestic monetary policy objectives.

** And while it may now seem like a long time ago, Prime Minster Abe himself suggested foreign bond purchases could be a tool used by the BOJ in testimony before Japan’s Diet in 2013. The likelihood of actually enacting that again, controversial policy, was swiftly then shot down by Finance Minister Taro Aso.

** There is precedent among smaller central banks for such measures (with apologies to the Swiss National Bank), where the pursuit of domestic monetary policy in a small open economy has been linked directly to the management of its currency regime and rate, justifying the purchase of foreign bonds; and in the Swiss case, of foreign equities, with nary a peep from its partners. 

** But the size of Japan’s economy and trade flows with the US and EU are huge compared to Switzerland, and there is little question a clearly FX-oriented policy, if adopted, would raise sharp protests from Japan’s major partners and perhaps even counter measures from the international community. That sensitivity could be all the higher given that Japan is nowhere close to economic crisis mode – indeed the economy is humming along rather smartly – and the deflationary mindset has been all but erased, except for an inability now to hit what may seem to many as a perhaps inappropriate 2% inflation target to begin with.

** In addition, FX policy per se is and has clearly always been the purview of Japan’s Ministry of Finance, and for foreign bond purchases to proceed in any way either the Diet would have to change the BOJ law that explicitly forbids the purchase of foreign bonds for the purpose of FX intervention, and/or the BOJ would have to lay out some mighty fine arguments for why this move does not, indeed, represent just that.

** All that is to say foreign bond purchases by the BOJ are extremely unlikely to happen – at least for now – at these levels and in this economic and market environment. But never say never, and should the US experience a crash in treasury prices and crisis spike in yields, one that were to be accompanied by weakness and a lack of confidence, rather than by strength, in the dollar, the BOJ could indeed present foreign bond purchases as a policy that simultaneously helps, rather than borrows, from Japan’s ally.

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