Established as the official currency of Japan by the Meiji government in 1871, the yen (ISO code: JPY ¥) is the third-most used currency in the world. With a long history of zero interest rates and little effect on the stimulation of the economy, the yen has been the world's biggest investor, and the preferred Asian reserve currency for decades.
In the Japanese Edo era, a central bank had not been established, nor any integration of a national financial market. Moneychangers engaged in a variety of tasks, including management of the national payment network and reserve management. Currency differed from region to region, silver being predominantly used in the West, gold in the East, and copper in small denominations across the country. Control of the exchange rates for gold and silver, as well as minting, was under the control of the Shogunate.
In the 1850s the treaty ports were opened as Japan began to embark on its international trade journey. Japanese industries were forced to compete with their foreign counterparts due to low tariffs under the unequal treaties with major Western powers.
1868 Meiji Government
1868 began a time of revolutionary change for Japan, marking the end of the feudal system and leading to a restructuring of power socially and economically. It also marked the decline of the Samurai and the rapid incline of industrialisation and westernisation. Drastic measures were needed to reshape the nation from a feudal state into a modern westernised trading partner.
Emperor Meiji, carrying little influencing power, accepted the advice of the men that had defeated the shogun. This cabinet of advisers moved with haste and began to implement a series of reforms that would both unify and strengthen Japan, including the establishment of their own military and economic control.
Japan became industrialised rapidly, shifting from an agrarian country to an up-and-coming industrial giant, forcing feudal lords to return land to the government and samurai warriors to be disenfranchised. These moves were believed essential for the survival of Japan as a nation, and for ensuring strength against Western imperial powers.
The rapid period of change and shuffling of the economy called for a currency that could be utilised as a trade tool, competitively and to make Japan's mark on a Western economy. First minted in 1869, the government enacted a New Currency Act in 1871 and marked the yen as the official currency of Japan. Like many currencies at the time, the yen found its roots in silver.
The word "yen" means round or circle object, and Japan's government hoped it would stabilise the monetary position of the country. Integral to the growth of Japan as a westernised nation, the introduction of the yen from July 1871 replaced the complicated copper-based monetary system of the Edo period.
1872 National Bank Act
Taking the American national banks as their model, the government enacted the National Bank Act, establishing four banks by 1874 and opening up opportunities for merchants to create new banks. As a result, 153 more were established by 1879. However, private banks began to mushroom and by 1883 there were 197 private banks. Due to a lack of management policy and experience, too many banks operated on a small scale without any knowledge beyond a feudal system. 
After a revision of the Act, the bank notes became inconvertible, which led to an excessive amount being issued. The national banks were forced to revise the Act for a second time, and after 20 years in service, withdrew their notes and later became recognised as ordinary banks.
1873 The Crime Of 1873
The standard silver dollar was omitted from coinage law passed by US President Ulysses S. Grant on 12 February 1873. This was the pathway to pivoting the US towards the gold standard and left countries unable to turn to silver for legal tender. The US had observed a silver standard, but famous gold rushes like that in California gave gold a considerably higher influence. The belief was that there was only one rational economic approach, which brought the Coinage Act in 1873.
After the devaluation of silver relative to gold in 1873, the yen lost a large value compared to that of the Canadian and U.S. dollars, which already adopted the gold standard.
1877 Seinan Civil War
In 1877 the Satsuma Rebel forces attacked the army of the Meiji government, with battlefields widely spread and civil war lasting a period of 7 months. The rebellion saw the loss of 14,000 lives from both armies, with a substantial number of wounded, both military and civilian, within the areas of the battle sites. In 1877 inconvertible banknotes were used to cover the costs of the Seinan Civil War, which led to a major devaluation of paper money and a public loss of trust. As the value of paper money decreased, the price of rice measured by paper money doubled.
By 1897, the yen was worth less than before, and Japan made a move to adopt the gold standard.
1882 The Bank Of Japan
To gain insight for the creation of its banking system, the Japanese government performed an in-depth study into the monetary systems of the U.S., Belgium, France and Britain. Despite differences in economic conditions between the nations, Japan found the examples it needed. The Bank of Japan was established under the Bank of Japan Act in June 1882, and by October began operating as the central bank of Japan. The bank became a determining factor in the economic and financial policies of the government.
Between 1886 and 1897, the yen depreciated against gold standard currencies, and the country's economy grew by 3% under the silver standard. By 1911 Japan had abolished the jurisdiction of Britain and revised unequal treaties with other Western countries. Japan was finally becoming recognised as a member of the international community and an emerging empire.
As promising as the rise to power seemed, Japan faced other issues.
1894 - 1912 The Pre-war Build-up
Japan was the first nation to successfully resist the encroachments of westernised nations, and set out on territorial expansion and colonialism. As Korea, China and Japan found themselves in a conflict of interest, the Sino-Japanese War began. China was defeated by Japan, which claimed Taiwan until pressure from Germany, France and Russia forced Japan to relinquish their Taiwanese territories. The intervention, known as the "Triple Intervention," led to Japan intensifying its armour stocks and preparing its military for whatever may come next.
New conflicts emerged between Russia and Japan over interests in Korea and Manchuria, ultimately leading to the Russo-Japanese war in 1904 – 1905. Winning the war, Japan annexed Korea completely in 1910 and transferred the Bank of Japan's note-issuing business to that of the Bank of Chosun (previous name for Korea). Korea was recognised as the first country to adopt the yen standard in East Asia. The win garnered national pride and international respect.
Japan set its sights on China for its next gradual phase of expansion due to its market potential and resources in abundance.
1912 World War l
The eruption of World War l caused uncertainty around the Japanese economy and the strength of the yen. As Western powers began to engage in the war, they suspended international trade, barring sales of textiles, machinery and chemicals to Japan. The fear of an adverse effect on Japan was quickly countered as the demand for domestic goods increased.
The global demand shifted to Japan instead of Europe, leading to an even bigger boost to the Japanese economy. This foreign demand was a welcome fix for the previously suffering macroeconomy hard hit by gold reserve losses and trade deficits. As exports rose, imports became slightly suppressed with only a moderate increase in overall investments within Japan. Instead, the output of capital stock increased and gold reserves accumulated while business stocks rose.
During WWI, the majority of yen was spent on emergency war expenditure. The bulk of the revenue was covered by a treasury surplus from tax increases, fiscal austerity, and a wartime excess profits tax. The Japanese nation was called upon by the French to intervene in the Siberian Intervention. Despite refusing at first, they were involved a mere year later and sent 72,000 troops.
The overall expense incurred by Japan for both wars fell at 1.553 billion yen, substantially less than other nations, owing to the conflict being focused on the European continent.
Japan balanced business and the economy as WWl ended, but the 1920 post-war recession meant that the business boom of exporting goods was over. An all-time price deflation was recorded with commodities dropping by up to 70% in price and the stock market a devastating 55%.
With the lack of quality and competitive pricing, the Japanese economy faced a series of recessions and banking crises. The Bank of Japan implemented a short-term policy to provide emergency loans to banks and industries that were facing bankruptcy.
1923 The Great Kanto Earthquake
Striking Tokyo and Yokohama and claiming the lives of over 142 000 people, the natural disaster was a major economic loss for Japan. The destruction left 60% of Tokyo's people without a home, and it claimed 90% of the homes in Yokohama. The event sparked a ripple effect of sadness across Japan and cost an estimated total of US$1.2 trillion.
By 1930 Japan made the move back to the gold standard under Finance Minister Inoue, at the original pre-war state of US$1 = ¥2. The Minister ascribed to a deflation policy that he believed was necessary to remove industries that were inefficient. England had opted not to return to the gold standard at the pre-war rate for consideration of a recession if an overvalued exchange rate was chosen. The deflation policy held by Inoue coincided with the 1929 Great Depression and Japan plummeted into a state of discontent as unemployment increased.
1931 Leaving the Gold Standard and Invading Manchuria
Japan sought to shift the economy and change its macroeconomic policy in 1931. Finance Minister Korekiyo Takahashi abandoned the gold standard in December of that year, implementing drastic measures to focus on monetary easing, currency depreciation and fiscal stimulus.
By 1936 the economy had grown at 6% per year with inflation maintained at low levels. The Bank of Japan obtained the power to implement open market operations by selling government securities, as a final attempt to regain control of the financial markets.
Military control increased with seats in major offices soon occupied by army and navy officers. Japan began the invasion of Manchuria in 1931, breaching the rules set out by the League of Nations. After pleading from China, the League of Nations imposed economic sanctions on Japan, which were fruitless and had little effect. Japan left the League of Nations in 1933 and in 1936 it signed the Anti-Comintern Pact with Germany (which was joined by Italy in 1937). They became known as the Axis Powers.
Once Manchuria was under Japanese control, the unification of currencies began with discussions of a standard. The currency of Manchuria was linked to the yen and became interchangeable, launching Japan into the trend of creating an economic bloc.
1937 - 1945 The Asia-Pacific War and Financial Repression
The Second Sino-Japanese War began following an incident between Chinese and Japanese troops near the Marco Polo bridge. A prelude to World War ll, the fighting spread into central China as the Japanese added more victories to their record. In 1940 Japan attacked occupied French Indonesia, further aggravating Great Britain and the U.S. The U.S. retaliation took the form of an oil boycott, pushing Japan to capture the Dutch East Indies and ultimately entering war with America and Great Britain.
The relationship between Japan and foreign countries continued to decline and the U.S. moved to impose and tighten sanctions against Japan. By 1941, the U.S. froze all Japanese assets in their territories, including a ban on all oil exports to Japan, leading to a shortage of materials for the economy. The black market surged and the wartime economy was poorly monitored.
The Bank of Japan vowed to fight the war under Japanese governmental control. By the end of the war, the bank had 8 billion yen stocked in government securities and another 14 million on loan to other banks aiding the war efforts. It also owed 21 billion yen in circulated banknotes. The 1882 Bank of Japan Act was called into question and shortly replaced by the Act of 1942, allowing all financial control to be handled by the Bank of Japan.
The snowball effect of the Sino-Japanese war extended over China as Japan occupied new areas and established banks, namely the Inner Mongolia Bank, Chinese Federal Reserve Bank and Central Reserve Bank. The currencies of these occupied areas were linked at par with the yen in order to establish a regional currency. Such progression on the behalf of Japan increased the identity of the yen, giving it the status of a key currency, and by default increased the country's political and industrial strength.
After 1941, Japan removed the USD and GBP exchange floatation, suspending transactions with the U.K. and U.S. completely and limiting transactions to Italy and Germany. The conversion between the yen and other currencies was based on a direct conversion rate dependent on multiple factors like standard of living, natural resources and production capacity. Japan moved to set the South East Asian countries up to be at par 1 to 1 and the value of these currencies dropped two-fold, allowing Japan to reduce the import price and encourage an internal circulation of goods within the country.
The decision taken to meet at par 1 to 1 did not aid the war recovery efforts. Inflation in Japanese occupied areas increased as imports from these areas declined and exports from Japan increased. Japan established a policy focusing on two measures:
- Charge the exporters a levy based on the difference between the domestic and export price
- Create a special conversion rate for Japan between Axis currencies and the yen
However, they maintained a rigid policy from the start of the Meiji Empire to exploit all other economies to the extent required to benefit Japan, through propaganda and regional dominance.
After WWII ended, Japan needed time to regain the respect and trust of the surrounding Asian countries. Despite the importance of an economic relationship with Japan, the U.S. arose as the new dominant power and boosted the post-war East Asian economies, allowing for liberal, symbiotic and multifaceted growth.
1944 Bretton Woods
The war efforts left Japan in a state of devastation, with transportation and industries severely damaged and a shortage of food that would continue for years. The yen became fixed at 1 USD to 360 yen via the Bretton Woods system. The system replaced the gold standard with the USD in 1944. Bretton Woods would allow for a currency system with standards that would, in theory, avoid a trade war.
1971 The Smithsonian Agreement
The rate of the yen to the USD remained unchanged and created a sweet-period where Japan was able to recover their economy, increase living standards and stabilise the liberal ruling party. The U.S. abandoned the gold standard in 1971, ultimately putting an end to the Bretton Wood system and forcing world currencies to realign.
The Smithsonian Agreement of December 1971 created a new USD standard agreement, and fixed the yen at 308 to 1 USD. Fearing the ripple effects of the appreciation of the yen, the Bank of Japan instituted easy monetary and fiscal policies. The agreement lasted 14 months before an agreement on a floating exchange rate was undertaken.
1973 The First Oil Shock
The yen appreciated rapidly against the USD and reached an exchange of US$1 to ¥254.40 in 1973. The first oil shock hit in December as Israeli-Arab conflict led to an embargo to all countries supporting the Israeli oil supply during the Yom-Kippur war, increasing oil prices steeply. Inflation increased by 25% in 1974, pushing the yen back into the 300 mark against the USD.
Japan, strongly disliking dependence on any other nation, intensified their research into raw materials, energy and substation of such. This research created a new industry of electronics, robotics and computers. The impact of the oil shock and the costs involved in the new discovery of technology meant Japan was ready for the implementation of changes and challenges at all levels. Despite a second oil shock (1979 - 1980), which they were prepared for, the economy did not decline in economic growth nor enter into a negative growth range.
1985 The Plaza Accord
After recording an increase in currency surplus, the yen did not further appreciate. Offshore appeal increased as Japanese investors were able to invest internationally, essentially increasing the supply of the yen and boosting the economy of the U.S.
The Group of Five industrial nations (France, U.S., U.K., West Germany and Japan) agreed to devalue the dollar against the Deutsche Mark and the Yen, known as the Plaza Accord. The intention was to shift the demand to American products from that of Japanese and to bring the USD down.
The 1987 Louvre Accord aimed to halt the decline of the USD and stabilise international currency through management of the floating currency system. The intention of manipulating currency to alter trade failed, and lowering the USD shifted capital flow and forced the selling of U.S. assets. By the end of 1988, the USD sat at $1: ¥120.45 and the Bank of Japan moved to immediately purchase U.S. dollars on behalf of the Ministry of Finance.
The financial sector of Japan faced an increase in pressure as nonperforming loans began to suffer the effect of the property value decline. Lending companies sponsored by the bank had aggressively lent money during the land bubble boom of the late 1980s, and were now suffering, eventually closed by the government in 1995. Banking and credit issues increased as smaller institutions could not pull through, and it all escalated into the Asian emerging-market financial crisis in 1997.
In response to the crisis, the Bank of Japan introduced monetary policy measures including a zero-interest rate policy. The USD to the JPY moved gradually to 148 as investors were allowed to borrow yen funds at zero interest rate to secure higher yields for both currencies.
In 1998, due to the Asian financial crisis and decline in demand for crude oil, Russia defaulted on their repayment to Japan, which triggered a risk-off environment. Carry trades quickly unwound and the USD fell to ¥101.30 in November 1999.
2001 September 11th
The knock-on effect of the low rates set by the Bank of Japan caused a fall in investments in Japan, favoured only by the carry trades due to the cheap funding costs of the yen. After 9/11, the Bank of Japan intervened to sell yen for USD. As the economy remained slumped in the post-inflation phase, the Minister of Finance spent 20.4 trillion yen in buying USD and selling yen.
2008 Global Financial Crisis of 2008
The US financial industry lacked regulations, and banks took the opportunity to engage in hedge fund trading with derivatives. To support this, they issued more mortgages and created interest-only loans that appealed to subprime borrowers. As the interest rates on these new mortgages set in, the Federal Reserve raised its funds rate.
The cost of housing fell along with the demand, leaving homeowners unable to repay their mortgages and unable to sell. Banks stopped aiding finances as the value of the derivatives fell, causing the ripple effect of a major recession. The yen had continued to fluctuate across the decade, shifting between U.S. financial market strain and yen carry trades. It eventually reached a 13-year high of ¥90.87 to US$1 in October 2008.
In 2010, the Bank of Japan and the government (without support from the West) took action to intervene and lower the value of the yen. This became known as the largest intervention in a day by any country, as exporters sold ¥2.13 trillion in yen and purchasing dollars.
2011 Tsunami Crisis
A powerful earthquake shook Japan and its economy in March 2011, followed by the explosion of the Fukushima nuclear reactor. This caused an appreciation of the yen as fears over the accident led to a stock plunge that pulled down offshore share prices too. Due to the monetary easing policy implemented by the Bank of Japan, the unlikelihood of a failing economy drove investors to buy yen. There was a speculation that Japanese investors would oust overseas assets and convert them into yen to help cover the costs of the disaster.
The economic policy of Japan has been influenced by the "Abenomics" debate for the last several years. Abenomics, coined by the Japanese Prime Minister Shinzo Abe, focused on a tri-fold agenda:
- Printing additional currency to increase the appeal of Japanese imports and generate a modest inflation rate of 2%.
- Stimulate short-term growth and achieve a budget surplus.
- Initiate a reform of various regulations to ensure Japanese industries become more competitive and increase Japan's appeal for foreign investors.
2018 EU Bilateral Trade Agreement
The EU-Japan economic partnership agreement removed the near €1 billion in annual tariffs and trade barriers imposed upon Japan, in order to encourage trade. This removed 97% of customs duty for Japan and thereby told the world that between these two booming economies, protectionism has been rejected as they manage the biggest trading network in the world.
Although Japan is the world's third-strongest economy, continuous deflation and slow growth, combined with Abenomics, has failed to correct high debt-to-GDP ratios, expensive imports and low prices. However, the devalued yen has allowed the nation to manufacture and export equipment, machinery, cars, steel products and electronics. By keeping the yen relatively low to the USD, Japan has extended their global market share.
2020 COVID-19 Pandemic
As Japan remembers the 9-year anniversary of the nuclear meltdown, tsunami and earthquake, it begins to scale back its memorials and events in the wake of the global COVID-19 pandemic. In a state of emergency, the government faces the pressure of preventing the spread of infection whilst balancing the economy as concerns of a recession become a fear to many. With 20% of gross domestic profit valued at US$1 trillion redirected towards the cause, testing centres ready and facilities available - the hope of Japan is to emerge unscathed.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…