Why The Yen is Losing Value

Earning a salary denominated in yen is getting increasingly painful. Here’s my analysis of the causes, and potential outcomes.

For most of the last decade, the yen has hovered around 105 to 110 yen to the dollar, but in just two months, the yen has lost almost 20% of its value against the dollar, and shows no signs of stopping. Meanwhile, the Bank of Japan has doubled down on its commitment to cap interest rates, implying that the yen may have much farther to fall as U.S. interest rates continue to rise in comparison.

What Interest Rates Have To Do With Exchange Rates

The strength of a currency depends on many factors, but chief among them are interest rates, and inflation rates. Trade balances also play an important role, but I’d like to focus on the first two for now.

Assuming similar rates of inflation, savers and investors will generally park their money in the currency that offers the highest interest rate. For large financial institutions, and wealthy investors, this typically means holding government bonds. Therefore, when the United States is offering upwards of 3.2% interest on 10 year bonds, compared to Japan’s offering of less than 0.25%, money flows out of Japanese yen and into U.S. Dollars.