The Mystery of the Yen Surge
By Kwok Ping Tsang

The Mystery of the Yen Surge

Jun. 14, 2016  |     |  0 comments

Since the launch of the “three prongs” of Abenomics (expansion of quantitative easing, fiscal stimulus, and structural reform) in late 2012, the Japanese yen has experienced a long period of depreciation against the US dollar. It went from 90 to 120 per US dollar, a massive 30 percent drop within 3 years. In January 2016, the Bank of Japan announced keeping its quantitative easing steady and, rather unexpectedly, added the negative interest rate as a monetary policy tool: financial institutions with reserves at the central bank over certain limits are subject to a 0.1 percent penalty. Strangely, right after the policy announcement, the Japanese yen reversed course and started a drastic rise. Within 3 months, it has appreciated against the US dollar by 10 percent.

This is a mystery. Under a double-expansionary monetary policy of quantitative easing and the negative interest rate, a strengthening currency is the last thing that comes to an economist’s mind!


The economics of exchange rates is one of my research interests, but, embarrassingly, I do not have much to offer! Exchange rates are incredibly hard to understand (some may argue that they are even tougher to crack than stock prices). Their ups and downs are large, sudden and persistent, and decades of effort from economists do not seem enough to tame these beasts.1 From complex time series modeling to historical studies over a century of data, from irrational animal spirits to rational pricing of macroeconomic fundamentals, economists have failed to find a model that works. The benchmark model is still a non-model: the best forecast for the exchange rate tomorrow is the one you observe today.

It’s difficult to make predictions, especially about the future. But the lesser holy grail of explaining the past movements of exchange rates is no easy task either. A theory is considered good if it can explain a small part of those ups and downs, leaving the rest as mysteries for another day.

The recent surge of the Japanese yen is such a mystery.

While constantly beaten up by those elusive exchange rates, economists persevere and never get tired of providing yet another theory.

Let me give you one.

I call it the “deflation threat cash hoarding” hypothesis. One of the original goals of Abe’s monetary policy was to reach a 2 percent inflation target in two years. Clearly, the Bank of Japan did not even come close to reach that goal, and, much like the postponement of the VAT hike, the “deadline” of the inflation target was pushed back several times. In January 2016, the head of the central bank, Haruhiko Kuroda, announced that the target will be reached by the fiscal year of 2017. While the public is losing faith in the ability of the Bank of Japan to bring inflation back up, the introduction of the negative interest rate was also likely to be interpreted as a desperate last move. Low inflation, or even deflation, is here to stay.

Under this threat of deflation, households and firms switch from other assets to cash holding, increasing the demand for Japanese yen. During this process of portfolio rebalancing, the currency rises. There are two observations that support my hypothesis. First, the rise in Japanese yen started right after the monetary policy announcement, a move which I believe had changed the public’s expectations of the future inflation path. The timing seems right. Second, there are recently some news reports on the increase in sales of safes in Japan, suggesting that the public is putting effort into hoarding cash.2

My hypothesis may be wrong, but this is exactly why I like it.

Economics is all about putting forward refutable hypotheses. If we see inflation rising back up and yet the Japanese yen is still strengthening (or that the sales in safes in Japan turn out to be not as dramatic as reported), my theory will be ruthlessly rejected.

Theories that are never wrong, or just really hard to be proven wrong, are of little help other than making you sound sophisticated. I have read elsewhere that the surge in Japanese yen is due to a phenomenon called the carry trade.3 Borrowing against a cheap currency like the Japanese yen, and then selling it to buy assets with higher returns, is a risky yet profitable business that can lead to the depreciation of the currency. After getting tired of funding their investment with Japanese yen borrowing, investors reverse course and the currency starts to rise.

While there are plenty of academic studies on the potential risk and return of such strategies, the carry trade explanation for the rise in Japanese yen is really hard to test. Not only are such trades not directly observable (you need to know the positions of individual investors), it is also not easy to explain why investors suddenly get in or out of such carry trades. Investors gain and lose “appetite” to borrow Japanese yen and take risk? Investors suddenly become more afraid of some global recession threat? You can always come up with some psychological (or even metaphysical) story to explain away any movement in the currency.

Will my hypothesis be rejected? Let’s wait and see.


1. One of my attempts can be found at Chen and Tsang (2013).

2. Surge in safe sales, ¥10,000 notes reflect sagging faith in economy (2016, February 28). The Japan Times. Retrieved from

3. Shaffer, L. (206, February 11). Yen jumps against dollar as carry trade wanes, despite BOJ’s negative rates policy. CNBC. Retrieved from


Chen, Y. & Tsang, K.P. (2013). What does the yield curve tell us about exchange rate predictability? Review of Economics and Statistics, 95(1), 185–205.

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