Japan’s Yen Debasement

 

The Japanese yen is now rivaling the Turkish lira as the weakest major currency in the world.

Despite the Bank of Japan raising its policy rate this week, the yen continued to slide. That may look contradictory at first, but in reality there is no mystery. What matters for the yen are longer-term interest rates, and those rates remain far too low given Japan’s enormous public debt. As long as this imbalance persists, the yen’s debasement will continue.

The chart above illustrates real effective exchange rates across major economies. These measures capture a currency’s true strength against trading partners, adjusting for differences in inflation. The shaded area shows the range between the strongest and weakest currencies. For years, the Turkish lira (blue line) has been the weakest globally. The Japanese yen (black line) has now fallen to nearly the same level.

So why is the yen weakening even after a rate hike? The answer lies in long-term yields. The yen is driven not by short-term policy rates, but by longer-dated interest rates, which remain artificially suppressed. This is evident in the chart plotting 30-year government bond yields against public debt across advanced economies. Germany’s 30-year yield sits above Japan’s, despite Germany having vastly lower public debt. The uncomfortable reality is that Japan’s yields are still being held down, and as long as that continues, the yen will keep losing value.

As the chart shows, the Bank of Japan remains a major buyer of government bonds on a gross basis, preventing yields from rising to levels that would prevail in a free market. Without this intervention, Japan’s long-term yields would be much higher—likely triggering a debt crisis. Given the scale of Japan’s debt burden, the country faces a stark choice: a debt crisis or ongoing currency debasement.

There is, in theory, a third path. Japan could pursue fiscal consolidation to reduce its debt. The government is asset-rich, which is why net debt stands around 130 percent of GDP, well below gross debt of roughly 240 percent. Selling financial assets and privatizing state-owned enterprises could meaningfully reduce debt. However, the political consensus for such measures does not yet exist. Until it does, the yen’s debasement is likely to deepen further.