Japan's Currency Crisis : Trouble in Paradise
Japan was one of the most phenomenal and developed economies of the 20th century which is often referred to as a paradise. After the devastating damage due to World War II, it rose from the ashes to become the second-largest economy in the world in just 23 years! During these golden years of development, its growth rate was in double digits, i.e., 10% in the 1960s, and even touched 12.9%!
But after this extraordinary phase of super-fast growth, Japan started facing an unexpected economic crisis which resulted in the slowdown of its economy for the past 30 long years! During this slowdown, it has witnessed Zero and even negative growth rates during global recessions. The imprints of this economic crisis are so deep that the Japanese economy is not able to recover even today.
Moreover, situations started getting even worse during the pandemic and Russia’s Ukraine war as its currency Yen started falling by 29% against the dollar! thus, leading Japan to the brink of an economic nightmare.
WHAT MADE THE YEN SO WEAK?
The roots of the problem can be seen in the 1970s when oil prices shot up when Iran deliberately stopped supplying oil to these countries. Since Japan used to meet its oil requirements majorly by import only, with this, this resulted in a shortage of fuel, leading to rising in the cost of fuel and thus inflation in the Japanese economy.
During the late 1970s, the Yen was drastically appreciating against the US dollar. But then in 1985 US, France, the UK, Germany, and Japan signed the PLAZA ACCORD where these countries decided to deliberately depreciate dollars against their respective currencies (to balance out the outstanding trade deficit in the US). But this agreement worsened the situation in Japan. The Yen started appreciating even faster. As a result, Japanese exports were hit hard as it became costlier for the international market to export from Japan. Therefore a lot of businesses in Japan suffered a shock wave due to falling exports of Japan.
To deal with this the government of Japan decided to decrease the interest rates and give loans more leniently to revive the affected businesses. As a result of this policy, the asset price bubble jumped into the picture – as more money was circulated into the economy, people started investing more in property, and prices of land soared high which further incentivized to the buyers to pledge this land to get more loans and hence more buyers to enter the market, buy more land, and increase the prices of land.
Once again, the Japanese government decided to intervene to rectify the problematic situation by sharply increasing the interest rates all of a sudden. But this did more damage than repair to the Japanese economy. When interest rates shot up, fewer people borrowed money from banks, so the number of buyers dropped suddenly resulting in a dire fall in the demand for land and hence the land prices started declining steeply. This made banks sell the land pledged as collateral which again increased the supply in the market and hence a fall in land prices.
The prices fell significantly, and even today Japan is not able to recover, i.e., the land prices are still lower than the ones in 1985. This cycle continued and resulted in a recession in Japan and the continuously declining Yen.
Since the Yen started falling against the US dollar (hitting one of the lowest levels last year ) it ought to increase the interest rates to be more competitive. But as seen earlier and frequently quoted by Japanese economists- the Japanese economy was too weak to be able to handle high-interest rates.
One direct impact of this economic nightmare was the aversion of foreign investors because of the volatility of the situation. They were now Norte attracted toward dollar-denominated assets.
Another important consequence seen in recent times is that inflation has started to increase in Japan which is good news for it ( unlike other nations !) Because for a long time, it has been facing falling prices and deflation which was causing low demand plus low consumer spending in the economy as prices were expected to fall even more in the future. This is why the news of Japan being able to cross its 2% inflation target was a sign of little relief.
Now, what impact could it have on the everyday life of common people? The logic being “Weaker currency results in costlier imports .“So, everything Japan buys/imports become costlier which people have to bear. Apart from this, Japan heavily depends on imported oil and gas. Thus, there is a constant rise in the price of fuels too.
LESSONS TO TAKE?
We saw how the world’s second-largest economy fell into such a dismal currency crisis. There are some lessons that we can take so that we don’t end up losing in a similar situation.
- Avoid drastic changes in the economy: One lesson is to use caution when making significant adjustments to economic policies, especially interest rates. Interest rate variations that were abrupt and severe contributed to Japan’s currency crisis. Policymakers should carefully evaluate any negative effects of such shifts and think about making gradual reforms instead. The stability of the economy can be disrupted and negatively impacted for a long time by sudden and drastic measures.
- Learn from historical mistakes: The signing of the Plaza Accord, according to the report, was a significant factor in Japan’s economic collapse. Midway through the 1980s, major economies came to an accord known as the Plaza Accord to devalue the US currency. Although it was meant to solve global trade imbalances, Japan suffered unforeseen consequences. India can take a lesson from this historical occurrence and proceed with caution while signing foreign treaties or accords that could have broad economic implications.
- Adapt policies as required: Another lesson that can be learned from Japan’s experience is the importance of economic policy adaptation in light of shifting conditions. During the country’s economic crisis, the Japanese government had a largely passive role, only sometimes stepping in. Long-term downturns can be avoided by being flexible and adaptable to shifting economic conditions at the right time.
- Encourage foreign investment: The importance of foreign direct investment (FDI) for economic growth cannot be underestimated. Japan could have undergone a restructuring in order to increase FDI and deal with its economic crisis. India can take note of this and concentrate on fostering an atmosphere that is favorable for international investment. This includes improving infrastructure, streamlining regulations, and offering incentives to foreign investors. Strong foreign investment can support economic growth, open doors for employment, and diversify the economy, making it less susceptible to financial crises.
To conclude, the currency crisis in Japan can act as a lesson to all of us, serving as a reminder of the significance of prudent economic policies, proactive flexibility, and maintaining a climate favorable to foreign investment. As Japan looks to the future, it must embrace these lessons to pave the road for sustainable progress, while other countries, like India, can draw inspiration from similar lessons to navigate their own economic routes with resiliency and foresight.
By Deepanshi Yadav
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