[Insight & Opinion] How to Escape the Weak Yen Trap

Vulnerable to U.S. Rate Hikes and Weak Yen
Need to Reduce Domestic Economic Instability Factors

[Asia Economy] As the United States raises interest rates sharply, countries around the world are adopting synchronized policies to raise rates as well in order to prevent capital outflows and reduce inflation. However, Japan is operating a contrasting accommodative monetary policy by increasing the money supply. The background behind Japan’s use of this de-synchronization policy is a strategy to escape a prolonged economic recession by boosting exports through a weaker yen. In fact, the yen exchange rate recently surpassed 139 yen per dollar, and there are forecasts that if the U.S. raises interest rates further, it could rise to the high 140 yen range by the end of the year. Haruhiko Kuroda, Governor of the Bank of Japan, has also declared that the current accommodative monetary policy will continue going forward.

The problem is that Japan’s weak yen strategy could have a significant impact on the Korean economy. Currently, the Korean economy faces heightened concerns about capital outflows due to the U.S. interest rate hikes, domestic trade deficits, and high inflation. The exchange rate has risen to the 1,320 won per dollar level, and it is expected to increase further with additional U.S. rate hikes. To stabilize the exchange rate, policy authorities are promoting a Korea-U.S. currency swap.

However, even if the Korea-U.S. currency swap stabilizes the exchange rate at the 1,200 won level, another challenge called the weak yen may arise. If the yen exchange rate rises to the high 140 yen per dollar range, the won-yen exchange rate will fall to the low 800 won range per 100 yen. Currently, the won-yen exchange rate is in the 950 won range, so the impact of the weak yen is not significant, but if it falls to the low 800 won range, there are concerns that Korea’s export competitiveness will be greatly reduced. In the past, when exports declined due to the weak yen and trade deficits expanded, the Korean economy often faced crises from capital outflows. The Korean economy is likely to fall into a currency policy dilemma where a high exchange rate causes problems, but a low exchange rate due to the Korea-U.S. currency swap also causes problems.

Of course, there is also a view that the weak yen is not as important as in the past. This is because Japanese manufacturing’s overseas production has increased, and Korea’s semiconductor exports, which do not compete with Japan, have a high share, so the weak yen does not have a large impact on Korean exports. However, since the industrial and trade structures of Korea, China, and Japan are all similar manufacturing-based structures, underestimating the impact of the weak yen is risky. Especially if the yen depreciates sharply, the impact could grow not only on Korean exports but also on service trade such as tourism, so caution is needed regarding the weak yen trap.

What is the solution to avoid the weak yen trap? The U.S. interest rate hikes can be addressed through the Korea-U.S. currency swap. However, when U.S. rate hikes and the weak yen occur simultaneously, there is no easy solution. First, it is necessary to stabilize the exchange rate at an appropriate level that can achieve both export growth and domestic price stability. To boost exports, the exchange rate needs to be higher, but to stabilize domestic prices, it needs to be lower. While stabilizing the excessively rising exchange rate anxiety through the Korea-U.S. currency swap, it is necessary to maintain an appropriate exchange rate considering exports to reduce the damage from the weak yen. It is also necessary to reduce domestic economic instability factors. Labor disputes intensifying due to wage increase demands from inflation, household debt from interest rate hikes, and the possibility of a real estate bubble collapse are factors that lower the credibility of the Korean economy. Raising interest rates to lower inflation expectations can reduce wage increase demands and labor disputes, and easing loan regulations and normalizing tax policies can prevent household debt defaults and real estate bubble collapse.

The Korean economy is vulnerable if U.S. interest rate hikes and the weak yen shock occur simultaneously. While U.S. rate hikes can be countered with the Korea-U.S. currency swap, the weak yen shock from Japan creates a currency policy dilemma, making solutions difficult. Policy authorities must establish a cautious response strategy to avoid falling into the weak yen trap created by Japan and prevent the Korean economy from being exposed to crisis risks.