Britain’s decision to leave the European Union has sent stock markets and currencies across the globe somersaulting. But the changes are particularly pronounced and worrying in Japan, where Brexit has caused the yen to strengthen more than any other major currency and where the Nikkei 225 last Friday plunged more than any index outside of Europe, its worst drop in five years.
In the 24 hours after Brexit, Japan lost nearly the same amount of wealth as after the 2011 nuclear meltdown that threatened to leave a wide part of the country uninhabitable. (The Nikkei bounced back a little Monday and continued to rise Tuesday, gaining .92 percent.)
Last week’s British referendum vote created a surge of global uncertainty not seen since the 2008 financial crisis. But where many countries are most concerned about new trade barriers and political instability across Europe, Japan is bracing for the Brexit pain because of its currency, which tends to strengthen any time investors worry about the world’s path. And Japan, to put it bluntly, does not want a strong yen.
Countries typically have a degree of control over the value of their currencies. But there’s just one problem: Economists fear Japan is nearly out of tools to fight back and deflate the yen.
The story of how the world’s third-largest economy arrived in such a vulnerable place is directly linked to its strategy over the past few years, when Japan — like many advanced countries — was using every last policy tool just to muddle along, in this case by keeping its currency as weak as possible.
Well before the Brexit, the Bank of Japan was on an unprecedented bond-buying binge. Interest rates were already negative. And for all this, Japan had earned itself an unsatisfying half-recovery, where wages were stagnant and growth was flat — but at least its big export-heavy titans were raking in record profits. The Nikkei between 2012 and 2015 had been one of the world’s fastest-growing stock markets — the one economic achievement for Prime Minister Shinzo Abe, who had pledged to pull Japan out of its two-decade stagnation.
But Japan earned that recovery by making a risky bargain: Its central bank was using crisis-time tools during a period of relative tranquility, meaning it had little in its pocket to combat the next crisis.
“Now, there’s not much the Bank of Japan can do” to help the situation, said Takuji Okubo, the chief economist at Japan Macro Advisors in Tokyo. “We could argue that the Bank of Japan has nearly exhausted its means to ease monetary conditions.”
Because Japan is such a big exporter, many of the nation’s corporations — think Toyota, Mitsubishi and Toshiba — receive the bulk of their income in foreign currency. When the yen gains, their profits erode. Take the example of Toyota, which manufactures cars at several major plants across the United States.
On the morning of the Brexit vote, $1 million earned in the U.S. would be 106 million yen back home. Twenty-four hours later, that same $1 million had the value of 102 million yen.
Because Japan is so export-heavy, its stock market and currency as a general rule move together; a weaker yen drives the market upward. But the yen tends to strengthen during times of global uncertainty because investors view the nation as a safe bet; Japan is the world’s largest creditor nation.
Typically, Japan’s central bank could fight back with some form or easing — say, by gobbling up more government bonds. But already, the Bank of Japan is buying up bonds far more quickly than the government is willing to issue them. In 2010, Japan’s central bank held about 8 percent of the government market. Now, its share is 37 percent, and due soon to rise to 50 percent.
Some economists say that the Bank of Japan is already too dominating a presence in the bond market and is drying up liquidity for other investors and banks. The Bank of Japan holds 426 trillion yen in assets, mostly government bonds. That figure is roughly three times what it was when Abe came to power in December 2012.
To keep the BOJ share of bonds low, the government could also speed up its issuance of bonds — so the government is creating them just as rapidly as the central bank is grabbing them. But that would increase the debt for what is already one of the world’s most indebted nations.
Japan could also play with its currency another way — by having its government sell yen for dollars, in a unilateral intervention that some media in Tokyo have speculated could happen soon. But here, the obstacle is largely political.
G7 countries, including the U.S., the U.K., Japan and others, have an agreement to manage their currencies together, and Japan would be likely to catch heat from Washington if its government staged a yen sell-off. After a G7 meeting last month in the Japanese city of Sendai, Treasury Secretary Jack Lew emphasized in a statement “the importance of reaffirming our exchange rate commitments, including our agreement to consult closely with one another and to refrain from competitive devaluation.” On the trail, both Hillary Clinton and Donald Trump have taken aim at Japan as a currency manipulator.
Even before the Brexit, the yen was gaining value, in large part because investors had determined that Japan was losing the ability to weaken its currency. Earlier this month, Toyota had said a strengthening yen could trim its profits by one-third. Now, Japan has a currency that is strengthening faster than nearly any on the planet, and with room to grow more. At the beginning of the year, 120 yen fetched $1. Now, 100 yen can be traded for a dollar. Okubo said he wouldn't be surprised if, soon, the dollar hits 85 yen, a level unseen during the Abe years.
“Once the yen starts to strengthen it could actually go a long way,” Okubo said.