The Fragility of the Japanese Yen and the Specter of a New Asian Currency War
The recent plummet of the Japanese yen to unprecedented lows has triggered fears of a new currency war in Asia, where competitive devaluations might emerge as a desperate tactic among neighboring countries. This scenario is seen as a plausible but undesirable path as nations strive to manage their weakening currencies against a strong U.S. dollar.
Escalating Tensions in Asian Currency Markets
Japan’s continued solo attempts to bolster the yen—despite massive interventions in the foreign exchange market pulling the yen up from a 34-year low against the dollar—seem to have limited lasting effect, increasing the likelihood of further devaluation. This vulnerability could potentially escalate competitive tensions between China and its close trading partners such as South Korea and Taiwan, intensifying the rumblings about possible devaluation of the Chinese yuan.
The Domino Effect of the Yen’s Decline
The yen’s sharp fall, triggered partly by the significant interest rate differential between Japan and other major economies, alongside a preference for U.S. assets among investors, has strained its Asian neighbors. Notably, at the end of April, the yen fell to its lowest point against the Chinese yuan since 1992—the currency of Japan’s largest trading partner. Additionally, the yuan’s value against the South Korean won and the New Taiwan dollar reached lows not seen since 2008 and 1991, respectively.
Henry Quek, State Street Corp.’s Director of Global Markets for Asia Pacific, expressed concern that if the yen continues to weaken significantly, a series of competitive devaluations could become a real possibility, although the term hasn’t been widely used for a long time.
Regional Impact and Reactions
Central banks across Asia have been actively supporting their currencies against the U.S. dollar, but the extent of the yen’s decline has been the most pronounced, undermining the export competitiveness of Japan’s neighbors. Kisoo Park, Senior Portfolio Manager at Manulife Investment Management, confirmed that competitive devaluation, whether intentional or not, is happening and affecting other countries in the region.
Market observers, including Arjun Vij, a portfolio manager at JPMorgan Asset Management, noted that a significant weakening of the yen directly pulls down other Asian currencies like the South Korean won and the New Taiwan dollar. Khoon Goh, Head of Asia Research at ANZ Group Holdings Ltd., suggested that it might be difficult for the won and the New Taiwan dollar to benefit from the tech investment boom in their countries until there’s a turnaround in the yen.
Long-term Considerations and Global Implications
While there is little concern over a financial crisis in Asia similar to the late 1990s—given China’s ample foreign exchange reserves, stricter financial sector regulation, and more developed domestic capital markets—the prospect of the yen weakening to 170-180 against the dollar poses broader risks to emerging market currencies. This is due to the yen’s role as a funding currency in carry trades, where investors borrow in countries with low interest rates to invest in higher-yielding assets elsewhere.
John Woods, Chief Investment Officer at Lombard Odier Hong Kong Ltd., highlighted the potential for severe market disruptions and the need for defensive strategies should these currency pressures lead to broad emerging market instability. The cascading effects could force funds invested in local markets to withdraw, triggering sell-offs in equities and a flight to safety in U.S. treasuries.
In summary, the instability of the yen not only threatens regional competitiveness but also poses a wider risk to global financial stability, particularly if China is compelled to let the yuan slide significantly to support its faltering economy. This situation warrants close monitoring as developments could have far-reaching implications for global trade and economic dynamics.
