How Far Can the Yen to USD Rate Rise?

The Japanese yen is in for a bumpy ride over the next few years, as all indicators point to depreciation against the U.S. dollar. The yen to USD exchange rate has been on a rollercoaster since the 2008 financial crisis, but long- and short-term fundamentals suggest only one direction for the Japanese currency’s value: down.

Since hitting a bottom of 76.9 in 2011, the yen to USD conversion rate has skyrocketed to 123.33 at the time of this writing. A lot of the momentum was driven by easy money from the Federal Reserve, a slate of policies that deflated the U.S. dollar.

The current government of Japan made an enormous mistake when it introduced a sales tax last year in April. Whatever growth the government had sparked in the economy was doused with cold water the minute that tax went into place. (Source: “Japan’s Tax Increase Puts Abenomics at Risk, ” The Wall Street Journal, August 29, 2014.)

Abenomics Could Have Saved the Yen to Dollar Exchange Rate

The Federal Reserve weakened the dollar to help U.S. exports bounce back, strengthening the economy at a time when the world was falling apart. As a result of its quick and decisive action, America recovered faster than any other advanced nation.

Then, as the Fed began unwinding its support of the economy, we started to see signs of life in the U.S. dollar. It rose in dramatic fashion during 2015, reflecting a great deal of optimism about America’s short-term prospects.

Too bad the same can’t be said about the Japanese yen.

The yen has floundered against the dollar over the last two years, remaining weak as the country continued a two-decade run of low growth.

Things started to look up when Prime Minister Shinzo Abe formed a party that seemed dedicated to reform. But then that spun out of control. Abe had a three-part plan to bring Japan roaring back to life: monetary stimulus to drag the economy out of deflation, a little bit of fiscal stimulus to kick-start growth, and structural reforms to make Japan more competitive. Those three arrows of “Abenomics” (named after its creator) could have worked if it wasn’t for the sales tax introduced in April 2014, which was the final nail in the coffin.

Under pressure from international authorities like the International Monetary Fund (IMF), Abe’s government implemented a sales tax that curbed spending almost immediately. Since the tax was put into place, Japan’s growth has slowed continuously, eventually turning negative in the second quarter of this year.

The Japanese Yen Could Hit a Demographic Wall

Even without the sales tax, Japan has a bunch of long-term headwinds that could keep weakening the yen to dollar exchange rate.

For instance, the country does not grant citizenship to children born inside Japan. That means that if you moved to Japan and spent years working there, paid taxes, and obeyed its laws, your children would not automatically become citizens. They would have to go through a long and difficult naturalization process.

By itself, this cultural aversion to immigration is a little odd, but not extremely dangerous. However, Japan has an aging population, with an expected reduction of 500, 000 per year for the next few decades. That kind of trend is hard to compensate for, even if the country was growing rapidly.

Without a regular flow of trained immigrants to bolster its workforce, Japan’s economy may continue to shrink. The Japanese yen could keep depreciating against the U.S. dollar and no one will have the power to stop it.

Courtesy of Profit Confidential, by Gaurav S. Iyer