Why Inflation Could Be Good News for Japan

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1:57Stephanie Flanders:I'm Stephanie Flanders, Head of Government and Economics at Bloomberg, and this is Trumponomics, the podcast that looks at pretty much everything in the economic world of Donald Trump. Today, I wanted to take a bit of time to consider how the economic world of Donald Trump and the rest of us is being affected by what's happening in Japan, more particularly by what's been happening to Japan's currency. Five years ago, 110 yen was worth a dollar. Today, that'll only get you 70 cents. Now, we're recording this on Tuesday, the 18th of August, and the yen's fallen again this morning, the same day that global bond yields, long-term borrowing costs for governments, have hit multi-decade highs.

2:42Stephanie Flanders:The famous long bond, the US 30-year treasury bond, was hovering around 5.4%. That's the highest in nearly 30 years. Now, Japan's falling currency isn't the only reason why borrowing costs are going up everywhere. We've discussed before there are lots of long-term structural forces that are driving the cost of money higher everywhere. And it's not helped by the US government and lots of others borrowing a lot when their economies are not in recession. But the US Treasury Secretary, Scott Besson, did care enough about the falling yen and its impact on markets to participate the other day in a joint intervention to shore up the currency.

3:21Stephanie Flanders:The first time the US has done this kind of thing in 30 years. So what's going on? After years of tackling falling prices, deflation, isn't it good news for everyone that Japan finally has a bit of inflation, even if that does mean a weakening currency? In these sultry August days, that seemed like just the kind of thicket of topics that we ought to be getting into on Trumponomics. And we have joining us from Tokyo, Taro Kimura, Bloomberg's senior economist. He leads our research into Japan's economy, and he did previously work as an economist at the Bank of Japan. Taro, thank you so much for joining us.

3:59Stephanie Flanders:Thank you for having me. Now, I should say, unusually for Bloomberg economists, you are also something of a social media sensation. You do lots of things online, but how many people have now viewed your very serious Japanese monetary policy explainer from a year or so ago? Yeah, thanks for mentioning that. My explainer for why Japanese monetary policy matters, exiting negative interest policy, I think it's watched nearly 4 million, at least above 3 million. I wasn't expected, but I'm super happy that people are interested in Japanese monetary policy. It's interesting, and we have to say just a little bit surprised.

4:34Stephanie Flanders:In Boston, we have Chris Anstey, who's a senior editor for Global Economic Coverage and much else. Chris, you're not as much of a social media star, but I think of you as a very kind of wise old hand on the interaction between global markets and the economy. And you have spent various chunks of your life in Japan. Thanks for joining. Happy to be here.

4:58Stephanie Flanders:Taro, this story I mentioned in passing, I mean, it begins with some good news for Japan, which is the return of inflation. Everywhere else, we've been feeling we had too much inflation and it was difficult to get rid of. But explain very briefly why Japan is different. Japan had experienced something called lost three decades, which is basically after the huge asset price bubble collapsed in early 1990s. We had serious banking problem and corporates need to retrench and labor union stopped requesting higher wages in order to secure employment. That kind of equilibrium continued even after Japan is getting a better shape.

5:41And what changed was the war between Russia and Ukraine, which triggered a higher energy cost, which is very detrimental for Japanese import costs. Corporates started to increase prices. And after corporates started to increase prices, the unions finally requested higher wages. And now we have a steady flow of inflation bolstered by higher wages. So now for the first time in many people's lives, workers are starting to enjoy higher wages. And that's a good thing about inflation.

6:15Stephanie Flanders:We have done episodes in the past when I was in Tokyo, and it was that crucial point about the wages, that you could get a sort of short-term increase in imported inflation, but it was getting a sort of process of reflating the economy was taking a very long time because wages were still quite low. And everything that you've described has come with the arrival of a very kind of striking new prime minister, Sanai Takeuchi, the first woman prime minister. She declared in Washington last year, Japan is back. The stock market has more than doubled since last year, which, you know, had a very long time in the doldrum.

6:52Stephanie Flanders:So a chunk of the country is feeling good. Companies are feeling a bit more positive about the future. Is that right, Tara? Yeah, generally, Takahichi started her tenure as a prime minister with a very, very large political support from voters. In the February lower house election, she made a historic win. And with that support at her back, she's proposing a very pro-stimulus policy, including a fiscal policy. She calls it responsible and proactive fiscal policy. The aim is forget about all the stimulus measures Japan has taken in the last three decades, cash handouts or whatever the measures to cope with crisis.

7:33What we are doing from now is rebuild our supply capacity and government commit to a long-term investment and crowd in private investment. I think the markets and including the voters liked the idea and that's why the stock prices are buoyant. And what's also the characteristic of her policy stance is she doesn't like the Bank of Japan's rate hike, and that's making a weaker yen issue exactly right now.

8:03Stephanie Flanders:Yeah, so I was going to ask you about that. So the byproduct of all this, although there's lots of positives, is you have a central bank and certainly a prime minister that's not very keen to see higher interest rates. But of course, we would normally see higher interest rates in the face of inflation. And without the higher interest rates, the yen doesn't look very attractive and it's falling. Is that the basic idea? That's right. I think an underlying reason why yen is so weak is many market expects, even though Bank of Japan is in a tightening cycle, the lower rates compared to the other major economies is going on because of the passive pressure from Takahichi government to the Bank of Japan.

8:43Stephanie Flanders:And Chris, I didn't want to make you sound too old, but I did mention that you had had a long history of engagement with Japan. And you reminded us in the newsletter today that we have been here before, you know, periods where the yen was center stage and it was changing its value pretty quickly. Yes, that's right. My first interaction with the yen was when I was a kid and moved to Japan in 1985, just before the Plaza Accord, which the U.S. entered into with four of its allies to drive the dollar down. And so I saw my pocket money grow in dollar terms, at least, as the months went by and the yen started soaring.

9:24And as you mentioned, the intervention that Treasury Secretary Besant engaged in on July 31st to buy the yen was the first such operation since 1998. And similarly, in 98, then Treasury Secretary Bob Rubin was essentially helping Japan at a time when he wanted to endorse economic changes there. So the big problem in Japan in 1998 was the financial system. And they made some pledges of writing the financial ship with the banks that were overloaded with all this bad debt from the burst bubble. And in this occasion, we see Besant acting most probably to help encourage the Takahichi administration to let the Bank of Japan move a little faster on interest rates.

10:17Besant has been concerned since last year that the Bank of Japan is behind the curve on fighting inflation. And this has resulted in periodic kerfuffles in the Japanese government bond market, which is spread over to the U.S. Treasury's market, which is what ultimately he cares about, and U.S. borrowing costs. So if he can engage in some yen buying here to stabilize the currency, stabilize global financial markets, it seems money well spent. Yeah.

10:49Stephanie Flanders:So you talked about the Plaza Record, and the Plaza Record was about strengthening the yen. But now we've had, as I mentioned, we've had sort of a good five years where the yen has been weakening. It's something of a mixed picture, isn't it, in Japan in terms of how people feel about the falling currency? And I guess there's also some people who are not particularly happy to have inflation if their wages aren't going up. Right. I think it's a very mixed story. It's really hard to say whether weak or yen is good or bad for the economy because traditionally, Japan's large corporates are either exporters or very big FDI, which means, you know, spread the business all around the world.

11:30So weaker yen basically is good for profits for large corporates. And actually, the level of the profits is surging and registering history high. And I think the Takahichi government basically thinks that's favorable.

11:43Stephanie Flanders:Because all these profits you make overseas are suddenly worth a lot more in Japan. That's right. That's right. If yen's got weaker. And another ambition of Takahichi is build up domestic supply capacity. So if there's a foreign company who are interested in investing in Japan, the weaker yen is good for them. So that's why Takai-chu initially wasn't concerned about a weaker yen. But given the dollar yen getting closer to 164, which is, you know, the yen is weakest since the level of the plaza accords. So there's always a news headline saying the yen is 40-year law, and that will accelerate inflation.

12:25So therefore, the inflation and the weaker yen is becoming easier to be on top of the political issue list.

12:34Stephanie Flanders:Yeah. And Chris, just going back to that, you gave us the kind of historical sweep on these big interventions. And I guess we'll get into in a minute whether or not it could be as successful, this latest round of intervention, as that sort of plaza accord, that slightly more coordinated, more formal agreement. But there were some pretty unusual aspects of this intervention. we have as a treasury secretary, someone who was a hedge fund trader, not someone who was sort of sitting in Goldman Sachs and elsewhere and has got used to sort of making money off the yen and other things over the years. And the way this all went down was both the tools and some of the sort of tricks around it were rather different than we've had in the past.

13:17Stephanie Flanders:Not least, he rather sort of obviously showed, allowed journalists to see his notepad at one point before he'd done the intervention. Yes, there was definitely a theatric quality, as you say, to this whole operation. Yes, there was a cabinet meeting actually out at Camp David where Besant was sitting with his back to the reporters and visible on his notepad was a to-do list that had one item, buy Japanese yen, $5 to$10 billion. He knew full well that this was visible to the reporters. This had happened before. He even mentioned it in a briefing at the White House several months previously. So he knew full well what he was doing.

14:01And then, of course, the actual intervention itself appears to have been via the euro, not dollars. And the U.S. Treasury has this specific kind of sometimes referred to as a little slush fund, the Exchange Stabilization Fund, which dates all the way back to the 1930s, actually. And it's got over$200 billion in it. And it's reasonably flexible in terms of how the Treasury can use it. It has, or had at least, some amount of euros and a number of other assets. And it appears that Bassett decided to sell euros for yen. He hasn't kind of spelled out exactly why he did that. Some speculation has it that, well, he didn't want to drive down the dollar specifically because, again, he doesn't want to depreciate U.S.

14:56assets, including treasuries, and drive up U.S. borrowing costs. One thing I wonder is, if you think about the foreign exchange market, dollar-yen is super liquid. It's the number two to euro-dollar. But the euro-yen cross is not all that well traded in comparison. So maybe he thought he could get a little bit more bang for the buck, or in this case, bang for the euro.

15:22Stephanie Flanders:There was another interpretation, which was that one of the possible reasons to do it through the euro was a concern that if the Japanese were sort of intervening in the market, they were going to be selling their US assets, their treasury bonds, pushing up the yields on those in order to be supporting the yen. That gets us into that question of whether all of this is really feeding into higher long-term interest rates, borrowing costs for governments and for everyone else. Chris, what do you think? The evidence suggests that indeed, Bethan is concerned about the impact on treasuries. And just yesterday, actually, the latest U.S.

16:03Treasury report on foreign holdings of treasuries. This is a little dated. It's back for June, but it did show that in the month of June, Japan's holdings fell by$26.4 billion. Now, they're still pretty hefty at$1.12 trillion, so there's a lot to work down. But it did show, as of June anyway, the direction of travel for Japan's holdings and perhaps fed into Besson's thinking in recent weeks.

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19:13Stephanie Flanders:It's a difficult topic for people who are not used to thinking about big investment flows around the world. But just those numbers that Chris has referred to, the holdings that the Japanese have, the official holdings of US Treasury bonds. And of course, Japan as a whole has a lot of foreign assets. It's built up, particularly in all these years where interest rates have been very low, where the economy has not been necessarily growing very fast. So what is the state of play with that? Why has Japan ended up with quite so many kind of assets abroad? And what's the possible implications if we continue to see that money flowing back now that things are looking a bit more upbeat in Japan itself?

19:56That's right. I think the starting gun was Japan's stagnant economy back in the 1990s. And because of the weak domestic demand, the corporate started to seek for foreign markets. And then simultaneously, Japan's aging population gets more serious. And that leads to a problem of Japan's labor shortages. So I explained Japan's economy is gaining vigor. We have now inflation, which is regarded a good thing for Japan. But if the Japanese corporates, which earns a lot of money from weak Korean by exports or a business abroad, if they try to invest domestically, they face labor shortages. So therefore, they can't find room to invest domestically.

20:46So they ended up continue to invest abroad. They continue to reinvest in like foreign factories or R &Ds. So that's going to creating a weaker trend in the end. And also the Japanese government agreed with the Trump administration that the Japanese corporate is going to make a massive investment in the United States. That's going to also enhance the trend. So therefore, I think the stronger FDI, particularly towards the United States, is creating a structural selling pressure to the yen. That accounts a very large part of the yen weakness since 2022. And the question is whether the Japanese corporate is going to eventually invest back in Japan, repatriate back in Japan.

21:33And that's what Takahichi is trying to do. Japan's labor shortage is something like Japanese manufacturers have machines, but they don't have operators. Japanese corporates have trucks or taxis or buses, but they don't have drivers. And what Takeichi is trying to do is invest massively in physical AI so that the machine can operate without human. If that's going to be successful, the Japanese corporate is going to rethink. Probably there's room to invest back in Japan. And that's what Takeichi is wanting to do. But there are many risks. Whether such a government investment works or not is a million dollar, billion dollar question.

22:16Stephanie Flanders:It's so complicated because we're talking about these long-term structural things, or at least the sort of supply side forces with real companies in Japan having their profits abroad and they're keeping them abroad. And that inevitably then still sort of feeding the pressure on the currency because they're keeping the money outside of Japan. But on the other hand, lots of people listening will have heard about the carry trade and other things. There's been these kind of shorter term flows of investment, which have been for many, many years have been based on the assumption that Japanese interest rates were going to stay very low.

22:49Stephanie Flanders:And now potentially, if we really do have self-sustaining inflation in Japan, those interest rates are just going to keep going up in theory, become a bit more normal relative to the rest of the world. Chris, this is something people have talked about over the years. So far, the transition has not been too bumpy. But as we move out of this very long-term regime for Japan, the deflation, the very low interest rates, how worried should we be that there's going to be some real bumps on the international markets as a result of that? Or have we already got through the worst, could you argue? It's impossible to know, of course.

23:27And there aren't great data points on the extent of leveraged trading in terms of borrowing cheaply in yen and parking it in higher yielding assets overseas. But what we do know is that the Bank of Japan over the past several years has moved from massive quantitative easing and sub-zero interest rates to quantitative tightening, shrinking their balance sheet rather than expanding it, and to positive interest rates with a 1 % benchmark now that's the highest in decades. And what have we seen? There's been no major financial crisis. They've actually, I would argue, made the transition pretty well.

24:15The transition began under former Governor Haruhiko Kuroda. He started to normalize slowly but surely, and it's continued under Governor Ueda. And every once in a while, during that process, people would say, you know, we don't understand Bank of Japan communications. They scale back their bond purchases, but they're saying they're still easing. I think that was all part and parcel of a calculated transition. I think the Bank of Japan was well aware of the danger of a huge unwinding of carry trades and the risk that that posed for the global financial system, and they were careful and measured in managing the transition.