Japan has been in an economic funk since the 1990s.  It was at that time that many speculated that they would overtake the U.S. as the global economic superpower, rather than China.  However, a poorly regulated financial system led to a housing crisis that they have yet to recover from.

With the recent election of Shinzo Abe as Prime Minister and his appointment of Haruhiko Kuroda as governor of the Bank of Japan, they have embarked on an extremely aggressive approach that involved significantly devaluing their currency.

It sounds odd that Japan would purposely devalue the yen, but it actually makes sense because they are highly dependent on exports.  Exports are goods that are produced in Japan but sold outside the country.   Consumers value goods that are inexpensive, so that’s where the yen depreciation becomes beneficial.  When the value of yen declines relative to a foreign currency, then that means that good will be cheaper to foreigners.

For instance, a weaker yen drives the price lower for a Nissan car, thus making it more attractive than a GM car to Americans.  This will lead to more Nissan cars being produced and less GM cars being produced.  Therefore, this has the effect of boosting auto employment in Japan, but lowering auto employment in the U.S.

Even though this is potentially damaging to the U.S. economy, it also makes Europe and developing countries even more vulnerable.  While the U.S. has a strong internal economy and is not as dependent on exports, that is not the case for emerging countries in Asia, South America, and Africa, along with parts of Europe.  A weaker yen places more pressure on those countries because their goods are now more expensive.  They are faced with two unenviable options.  Either accept that their currency will rise and cause unemployment to rise or also devalue their currency and risk higher inflation.

Theoretically, Japan is more able to absorb a weaker currency than most countries.  This is because their citizens historically have high saving rates.  Even though a weaker currency typically drives people to buy more goods and allow businesses to drive up prices, that might not be the case in Japan where they are frugal in their purchases.  This is one of the reasons why Japan has been plagued with deflation despite significant monetary and fiscal expansion.  On the other hand, they would benefit through increased employment opportunities when they see more of their goods being bought abroad.

However, there is a downside with this strategy.  Bond investors are already leery about Japan’s excessive debt levels that actually dwarf the U.S.  The danger is that bond investors will flee Japan, which would drive their interest rates higher.  If this occurs, then that will make it more difficult for Japanese businesses to gain access to cheap credit and thus this would depress future economic growth.

Even though these events are taking place across the Pacific, the ramifications of a weak yen are potentially huge.  It could lead to a currency war that can result in higher global inflation and create more economic turmoil worldwide.  A slow growing global economy means less opportunities for Americans, who are becoming more reliant on exports to increase employment and boost their standard of living.

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