Exploring the Japanese yen – a ‘safe haven’ currency?

The foreign exchange market, also known as the FX or forex market, is the main way currencies are traded. Even though there are 180 currencies in the world, in circulation in 197 countries, over 83% of forex trades are conducted in just seven currencies. The US dollar and the euro are the most used, followed by the yen.

The yen is the official currency of Japan and is often abbreviated as JPY or ¥. It accounts for just under one fifth of trades on the forex market and is the most traded currency across the Asian continent.

The yen has a deep and complex history, impacting investors globally. It’s often referred to as a ‘safe haven’ currency during times of hardship – but should it be?

We take a closer look and explore where the yen could go from here.

This article isn’t personal advice. If you’re not sure if an investment is right for you, ask for financial advice.

History of the yen

A good place to start is at the beginning. The history of the yen stretches back over 100 years. Its origins can be traced back to the era of the Meiji government, who were in power during the late 19th century.

Japan was in the process of modernising its economy, during the early years of the Meiji’s reign. It wanted to open to more foreign trade and investment, while also establishing a stable and reliable currency system.

In 1871, the government decided to introduce the yen as its currency. Some regions in Japan retained the right to print their own currencies. However, this changed in 1882, when the Bank of Japan (BoJ) was established to control the money supply.

For many years, the yen, like most other currencies, was pegged to the gold standard. It was a system in which a country’s currency value was linked to gold. This was common practice until World War I. But the upheavals of the war left many economies and countries devastated, so it was extremely difficult to continue converting currency to gold.

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Some governments also felt linking to gold restricted their ability to freely increase the supply of money to help fund things like military expenditure or efforts to rebuild the country.

Japan abandoned the gold standard entirely in 1931, causing the yen to lose a lot of its value. Because of the fall, Japanese exports became more appealing to foreign buyers as Japanese goods became cheaper. The economy began to bounce back, but the yen fell once more during, and after, World War II.

Fast forward to the 1970s, and Japan’s economy was growing rapidly, boosted by the weak yen and strong export demand. Japanese goods had once again become more affordable for foreign investors. Its economy shifted into the next gear during the 1980s and became an envy of the world. Exports drove the economy, stock markets surged, and the property sector went from strength to strength.

However, nothing lasts forever. The yen rose in value against the dollar, peaking in 1985, making Japanese exports more expensive. To prevent the yen from appreciating too much, the government had to intervene. Japan’s economic bubble then burst in the early 1990s and the period that followed is known by many as ‘The Lost Decade’.

The country entered a deep recession and experienced years of incredibly low economic growth and an ever weakening yen. Unlike in the past, a weak yen didn’t translate into roaring export demand. Many people were put off investing in Japan because of the significant economic drop off. The government attempted to keep the value of the yen low in order to remain competitive abroad and rekindle interest in Japanese goods.

The yen has since recovered some ground, but it’s continued to fluctuate in response to global economic events, including the great financial crisis in 2008. More recently, the yen has been heavily impacted by COVID-19 and the conflict in Ukraine.

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The currency has hit the headlines, mainly due to record falls in its value and questions around its ‘safe haven’ status are coming to the fold.

Is the yen a ‘safe haven’ currency?

Investors have long sought the safety of the Japanese yen when times get tough. This is because the yen is perceived as a safer and more stable currency, and therefore more reliable, in times of market stress. It’s very liquid so can be traded easily and is generally backed by a stable government.

Before 2021, this was mostly true. But with the gap between US and Japanese interest rates widening, coupled with rising inflation, the yen dropped to its lowest level versus the dollar in 40 years, during 2022.

Some now argue it’s become too volatile in difficult periods and loses value in a similar vein to other non-safe haven currencies.

A weak yen has also piled on the pressure to Japan’s economy, in particular its imports and exports. While a weak yen has historically boosted Japanese exports, some Japanese companies have shifted their production efforts overseas over the last decade. That means a weaker yen isn’t benefiting export companies as much as it once did.

Japan is also reliant on importing a lot of resources, mainly energy. A weak yen makes importing these resources much more expensive, which is stretching domestic income, but also increasing inflation.

A ‘safe haven’ currency needs the backing from a strong trading environment. Japan seems to have lost this more recently, which is why some feel it no longer warrants the title.

Where does the yen go from here?

This is a tricky question to answer. The value or direction of currencies is a notoriously difficult thing to predict – there are a huge number of variables that can impact the price of currency, so it can be volatile and unpredictable.

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The yen has generally depreciated against the dollar since the beginning of 2021, reversing roughly four years of gradual appreciation. Despite this drop, the yen could fall even further given the impact of wider economic events.

The yen’s value has fallen primarily because the BoJ has kept interest rates at rock-bottom levels, while the Federal Reserve has increased US rates rapidly to help curb inflation. If the gap continues to widen, the yen is likely to continue to fall.

However, with the latest issues in the US, namely the Silicon Valley Bank collapse, it’s unlikely to continue increasing rates at the same level. This means the gap between the two currencies could stop increasing, or perhaps even decrease a bit.

The yen could be set to bounce back this year though and the BoJ possesses the ability to kickstart this by changing its monetary policy.

The BoJ have continually shocked markets by refusing to raise interest rates. The value of the yen plummeted, and the government had to intervene, spending ¥trillions, to prop up the currency. There have been three interventions since September 2022. Though, this is a rare occurrence and before 2022, the last intervention happened in 1998.

The BoJ more recently announced it would loosen its government bond yield targets (instead of a rate hike). Optimists, with their glass half full, believe this could be the beginnings of policy normalisation in Japan, including some sort of rate hike.

With a falling yen against the dollar, the Japanese people have been left with a difficult choice. Hold on or move money into foreign currencies. Banks have noted a surge in the latter. It could get to the point where the only option is to follow suit and increase interest rates. If this happens, the yen will likely strengthen, though there are no guarantees.

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