Are you wondering why the Yen seems considerably cheaper than other currencies, such as the U.S. dollar or the Euro? It’s a common question, especially among new forex traders.
The main reason the yen is so cheap is due to Japan’s monetary policy. Japan intentionally keeps its currency’s value low through a policy of low interest rates to promote economic growth. This approach makes Japanese exports more competitive and stimulates investment.
Continue reading as we unpack the reasons that contribute to the yen’s value and how these influence international trade and investment.
A Quick Course on Currency Value
Before diving into the reasons why the yen is cheap, it’s crucial to understand some basic principles about currency value, inflation, and the foreign exchange market. Currency value can seem complex and even intimidating. But a solid grasp of a few fundamental concepts can go a long way toward enhancing your understanding.
What is a Currency’s Worth?
Essentially, a currency’s worth is determined by how much you can buy with it. This is often compared with other currencies. It’s why you hear terms like “$1 USD equals XYZ yen”. The value of a currency is also partially tied to a country’s economic outlook, including factors like employment levels, GDP growth rates, inflation, and more.
Inflation and Deflation: A Balancing Act
Inflation is when prices for goods and services rise, and consequently, purchasing power is falling. Central banks attempt to limit inflation — and prevent deflation — to keep the economy running smoothly. Deflation, on the other hand, is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0%. While deflation seems like a great condition because consumers can buy more with their money, it can actually be detrimental to the overall economy. Stable prices enable consumers and businesses to make spending and investment decisions with more confidence.
An Introduction to Forex (Foreign Exchange) Markets
For currencies like the yen, the bulk of trading happens in the Forex (foreign exchange) market. This is the global marketplace for exchanging national currencies against one another. Because of its global reach in commerce and trade, the Forex market is the largest and most liquid financial market in the world.
In the Forex market, currencies are traded in pairs. For example, when you exchange US dollars for yen, the currency pair would be USD/JPY. The value of the yen is heavily influenced by its interactions with other currencies in this market. Understanding Forex markets can help us understand why the yen often appears “cheaper” compared with currencies like the US dollar or the euro.
Unraveling the Mysteries of the Japanese Yen
The Japanese Yen, one of the most widely recognized currencies in the world, often raises eyebrows due to its seemingly ‘cheap’ nature. Many people are perplexed when they hear about exchange rates such as 100 Yen for a US dollar. But, It’s essential to understand that cheapness or dearness of a currency doesn’t necessarily signify the strength or weakness of an economy. To shed some light on this, let’s take a historical perspective and explore why the Yen is often seen as ‘cheap’.
The Historical Perspective: Yen Through the Ages
The Japanese Yen was first introduced in 1871, replacing the Edo period’s complex monetary system. The Meiji government wished to modernize Japan’s economy and followed the European decimal monetary system. Thereafter, Japan faced various periods of inflation, deflation, and financial crises that influenced the Yen’s value.
The biggest hit on the Yen was during and after World War II when high levels of inflation led to a significant depreciation of the Yen’s value. The Bretton Woods system was introduced in 1949, pegging Yen to the US dollar at a fixed exchange rate of 360 Yen to 1 US dollar. This rate remained unchanged until 1971, explaining the Yen’s high nominal value.
Understanding the Yen’s ‘Cheap’ Reputation
The perception of the Yen being ‘cheap’ is often due to its high nominal value compared to many other currencies. However, this doesn’t accurately reflect the real value or purchasing power of the currency.
High Nominal Values Vs Real Value
Nominal value, by definition, is the face value of money, and it doesn’t reflect the inflation or purchasing power. So, when we say ‘100 Yen equals 1 US dollar,’ we’re talking about nominal value. On the other hand, the real value of money takes into account inflation and the goods or services you can purchase with that money.
For instance, while 1 USD can buy you a soft drink in the United States, the same 100 Yen (equivalent to 1 USD) can buy you the same soft drink in Japan. Thus, the purchasing power is equal.
Therefore, the often perceived ‘cheap’ reputation of the Japanese Yen is due to its high nominal value against other currencies, not necessarily its real value or strength. It’s important to understand that the Japanese economy is one of the largest and most robust in the world, and the Yen continues to be a significant reserve currency globally.
Deep-Dive into Japanese Economic Policies
The economic policies in Japan, particularly the moves by the country’s central bank – the Bank of Japan (BOJ), play a significant role in making yen so cheap.
The Role of the Bank of Japan (BOJ)
The BOJ oversees the money supply in Japan, with its policies affecting the value of the yen, the level of interest rates, and the state of the economy. The central bank has been pursuing policies that intentionally weaken the yen in an attempt to fight deflation and stimulate the economy.
The BOJ’s Monetary Policy
The BOJ’s monetary policy has been characterized by a so-called “quantitative and qualitative monetary easing” (QQE) approach. This involves buying large amounts of Japanese government bonds as well as other assets to inject more money into the economy and push down interest rates.
The purpose of this massive asset purchase program is to stimulate the economy by making borrowing cost cheap, encouraging spending and investing. However, a side effect of this policy is that it puts downward pressure on the yen.
Interest Rates: The Lowdown on the Low
Since the late 1990s, the BOJ has maintained very low interest rates, even implementing a negative interest rate policy in 2016. The low to negative rates discourage the holding of yen as it yields little to no returns compared to other currencies.
Japan’s Unique Deflation Problem
Japan has been facing a unique problem called “deflation,” wherein the prices of goods and services and the level of wages fall over time. The BOJ has been battling deflation for decades, with its slew of policy measures such as the QQE and negative interest rate policy.
These anti-deflationary measures include reducing interest rates and pumping money into the economy in an attempt to increase spending and prices, but have kept the yen weak.
The deflation issue in Japan is largely structural, rooted in the country’s aging population and weak domestic demand. This situation has only added to the complexity of the BOJ’s task to stimulate the economy and increase the value of the yen.
The Ripple Effect: Globally Speaking
In the world of foreign exchange, the Japanese Yen carries a unique reputation as a “safe haven” currency. This term is typically used to refer to currencies that are dependable, secure, and remain stable during periods of global economic uncertainty or crisis.
The Yen gets its status as an economic “safe haven” for a few reasons. A primary one is Japan’s strong and stable economy, on top of an extremely large current account surplus. The nation is known for its prominent fiscal discipline, holding the third-largest economy globally closely after the USA and China.
|Economy rank (GDP)
How Cheap Yen Impacts International Trade
While the Yen is often perceived as being cheap, it is important to consider its impact on international trade. A lower value of Yen relative to other currencies means that Japanese goods and services become cheaper for foreign consumers, thereby potentially boosting Japan’s exports.
In turn, this increases the demand for the Japanese Yen because foreign consumers need to buy Yen to pay for these goods, pushing up its value. This often creates a cycle, known as a “currency war,” that countries work hard to avoid.
Beyond this, a cheaper Yen also means that Japan can import goods and raw materials at higher costs. This is because they need to spend more Yen to buy other currencies to pay for these imports. Therefore, while a cheaper Yen may be beneficial for Japan’s exports, it also has its downside which can affect the balance of trade.
- Increased export due to cheap yen
- Inflated import cost as more yen needed to buy the same value of foreign currency
- Impact on the country’s balance of trade
Thus, the value of the Yen and its classification as “cheap” or “expensive” has deep ramifications not only on Japan’s economy but on international trade and foreign exchange as a whole.
Tales from the Other Side: High-Value Currencies
Let’s switch gears and delve into the world of high-value currencies. You may wonder why the Yen is so cheap compared to, say, the British Pound, the Euro, or the U.S. Dollar? To understand this, we need to take a look at the “Big Guns” of the world of Forex: the GBP, EUR, and USD.
The Big Guns: GBP, EUR, and USD
The British Pound (GBP), the Euro (EUR), and the U.S. Dollar (USD) have some of the highest values among global currencies. This is due to a variety of factors, including the strength and size of the corresponding economies, foreign exchange market demand, and the policies of the central banks.
|GBP (British Pound)
|Bank of England
|European Central Bank
|USD (U.S. Dollar)
These currencies are widely used in international trade and as global reserves, which creates high demand. Furthermore, central banks often employ policies to ensure the stability and strength of their respective currencies.
Strength in Numbers: The Power of Strong Currencies
Having a strong currency has numerous advantages. It can attract foreign investors because it suggests economic health and stability, which in turn can lead to positive effects like job creation and economic growth. Moreover, strong currencies can afford to import goods and services at a cheaper rate because of their high purchasing power.
While the Yen may appear cheap in comparison to these big guns, it’s important to remember that the value of a currency is relative and affected by various elements, not just its face value.
So, why is the Yen so cheap compared to the GBP, EUR, and USD? This largely comes down to Japan’s monetary policy decisions and economic factors, which we will discuss further in the next sections.
In the Forex Market: Yen’s Performance
The Foreign Exchange Market, commonly known as Forex, is where national currencies are traded. The exchange rate at which currencies trade against each other is determined by a multitude of economic factors such as inflation, political stability, economic performance, and more. The Japanese Yen (JPY) is one of the most frequently traded currencies on this market.
When you observe the currency values in the Forex market, you might wonder why the yen is so cheap, especially when compared to other major currencies like the US Dollar (USD), the Euro (EUR), or the British Pound (GBP).
|Exchange Rate (As of 2021)
While it might seem like 1 yen is negligible when pitted against other dominant currencies, it’s important to note that the perceived value of a currency – whether it appears strong or weak – doesn’t necessarily mirror the country’s economic strength or prosperity. The exchange rates that you see are largely a result of a country’s economic policy.
Relatively low nominal value of the yen isn’t indicative of a cheap or weak currency. In fact, it’s the result of Japan’s explicit policy of maintaining a low and stable rate of inflation and by association, a low nominal interest rate. It’s more about the economic and inflation policies rather than the value of Japan’s economy itself.
Keep in mind, the “cheapness” of the yen when compared to the dollar or pound is purely a question of denomination. For example, just as pennies are units of the dollar, yen are the units of Japan’s national currency and hence should not be compared straightforwardly with dollars or pounds.
The key takeaway here is that a lower denomination doesn’t necessarily correlate with being “cheap” or “weak”. Equating lower valuation with weakness can lead to misunderstandings about a currency’s functionality and strength in the global economy.