Curse of the Strong Yen

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As of October 5 the Japanese Yen has appreciated 12.9% against a standard basket of currencies, ahead of the Swiss Franc (10.75%) and the RMB (10.47%) since 2005. This compares with an 8% decline in the US dollar and a 19.3% depreciation in the UK pound. The Yen is presently the world’s strongest currency.

This strength of the currency is not warranted by economic fundamentals. As this chart shows, Japan is suffering from deflation, which appears to be getting worse. When a currency that should depreciate is not allowed to depreciate because of capital flow dynamics, the price level falls. The deflation is telling us that the Yen should depreciate.

The LDP’s downfall is related to a stagnant economy, which the mere change of leadership clearly did nothing to avert. The problem is that the economic stagnation is expected to continue for as long as the Yen remains strong against its economic fundamentals. The fate of the Democratic Party hinges on whether the Bank of Japan will avert the continuous surge in the Yen.