Yen's fall microcosm of mature economy in structural decline

Despite a recent bounce, the yen remains pinned below the psychologically critical 160 mark against the dollar — a level long viewed by the market as a last line of defense.

Once an undisputed safe-haven currency, the yen is now one of the world's worst-performing major currencies. Its relentless slide lays bare the fragility of Japan's political and economic foundations, exposing a jarring case of policy schizophrenia.

Officials continue to tout a narrative of "moderate recovery" for Japan's economy. Supporting this optimism is the fact that while the yen languishes at 40-year lows, the Nikkei has surged to heights not seen since the late-1980s bubble era. Politicians are quick to frame this as a sign that Japan is finally shaking off its "lost decades."

Yet the stark divergence between stocks and the currency reveals deep internal contradictions. To a significant extent, the plunging yen has engineered an imported bull run. The Nikkei 225, dominated by exporters like Toyota, Sony, and SoftBank, benefits directly as a weaker yen inflates the value of repatriated overseas earnings. However, this disconnect from the tepid underlying economy has investors on edge; what passes for a "recovery" feels more like a disjointed solo dance.

The contrast becomes even starker beyond the equity market. With Japan heavily reliant on imports for energy, raw materials and food, the currency crash has unleashed a tide of imported inflation. Consumer prices have breached the 2 percent policy target for four straight years, while the Engel coefficient (the proportion of food expenditure in total consumption expenditure) for households hit 29.4 percent in the third quarter of 2025 — its highest level since 1981.

While listed multinationals celebrate inflated paper profits, the vast majority of smaller firms are being squeezed to death, burdened by rising operating costs. According to one survey, corporate bankruptcies attributable to yen depreciation rose by 32.3 percent year-on-year in the first half of this year. Meanwhile, despite union-led nominal wage hikes of 5 percent over two years, real wages have declined for four consecutive years, failing to keep pace with inflation.

As foreign tourists and property buyers snap up bargains in what has become Asia's biggest "discount store", domestic purchasing power is evaporating.

As Robin Brooks of the Brookings Institution noted in May, measured by the real effective exchange rate (REER), the yen has fallen below even the Turkish lira, largely considered one of the world's weakest currencies. Bank for International Settlements data show the yen's REER has collapsed from a 1995 peak of 193.95 to just 67.73 — a two-thirds wipeout of its value.

On the surface, the primary driver appears to be the yawning 300-basis-point gap between US and Japanese interest rates, which serves to fuel a low-risk carry trade bonanza: borrowing low-interest yen and buying high-interest dollar assets, thereby creating a lasting siphon effect of shorting the yen. But Tokyo's repeated interventions — including a record 11.73 trillion yen ($73.6 billion) spent in just one month to buy the yen in the market and hiking the benchmark rate to its highest level since 1995 — have failed to stem the tide.

Clearly, this is no longer just about interest rate differentials; it is a symptom of deep structural malaise. At the heart of the crisis is a catastrophic policy mix: the financial authorities press the brakes with rate hikes, while Prime Minister Sanae Takaichi slams the accelerator with reckless fiscal abandon. Ignoring a debt-to-GDP ratio of 240 percent, her administration is doubling down on massive stimulus and defense spending. This fiscal profligacy has spooked the bond market, sending the 10-year benchmark government bond yield soaring to a three-decade high of 2.9 percent.

The resulting surge in borrowing costs for the government, corporations, and households is choking off the real economy.

This places Japan's economy squarely in the grip of what economists call an "Impossible Trinity": expansionary fiscal policy demands low rates, low rates crush the currency, a weak currency forces tightening, and tightening strangles the very fiscal expansion it seeks to enable. Takaichi's political gamble is proving to be a ruinous wager on the future of the Japanese economy.

Today, the yen's decline is a microcosm of a mature economy in structural free fall. Investors are shorting the yen, betting on the persistence of Japan's woes: a shrinking population, unsustainable debt, hollowing out of industry, the fading dominance of its once-mighty manufacturing sector, and in particular, the worsening geopolitical environment. The shift from perennial trade surplus to chronic deficit further erodes the currency's intrinsic worth.

While Takaichi clings to her "weak yen is good" dogma, markets understand the truth: a sovereign's exchange rate is the ultimate barometer of national competitiveness. A currency's persistent plunge signifies a collective downgrade of the country's potential — a massive vote of no confidence. How, or even if, Japan rescues its currency will not only determine its own economic fate but also reverberate across the global financial system.

The author is chief researcher at the China Watch Institute, China Daily.