Japan’s weak yen masks a structural crisis

(Edited and refined by Candice Chan, with the assistance of AI translation.)

The Japanese yen has fallen to its weakest level against the US dollar in nearly 40 years, at one point slipping below 162 yen to the dollar. The market has generally attributed this to the widening interest rate differential between the US and Japan: while the US Federal Reserve has continued raising interest rates, the Bank of Japan (BOJ) has maintained an ultra-loose monetary policy, encouraging investors to borrow low-cost yen and channel funds into higher-yielding US dollar assets.

However, this is merely the immediate trigger for the yen’s weakness, not its underlying cause. The depreciation of the yen is not simply a monetary phenomenon, but a reflection of Japan’s structural economic problems. Population ageing and decline, stagnant productivity growth, fiscal constraints, weakening industrial competitiveness, changes in the composition of overseas earnings, and intensifying global technological competition have all eroded the economic foundations that once supported a strong yen.

The real challenge, therefore, is not how to strengthen the yen through interest rate hikes or foreign exchange intervention, but how to rebuild Japan’s long-term productive capacity and technological competitiveness. Exchange rates ultimately reflect economic strength; they do not determine it.

A structural issue, not cyclical

Financial markets often explain exchange rate movements in terms of interest rates. Yet interest rate differentials merely amplify existing trends; they do not explain why Japan has remained trapped amid low interest rates for decades.

The fundamental reason lies in Japan’s ageing population, shrinking workforce and persistently weak productivity, all of which have suppressed economic growth, wage increases and inflation, making it difficult for the BOJ to normalise monetary policy in the way other major central banks have done. Weak structural growth has also reduced the attractiveness of Japanese assets to international investors, suppressing long-term demand for the yen.

Among these factors, demographic challenges are particularly critical. Japan is not only ageing rapidly, but also experiencing sustained population decline. A shrinking labour force lowers potential economic growth while weakening consumption, investment and innovation. At the same time, rising pension and healthcare expenditure places an ever heavier burden on public finances. As demographic trends are long-term in nature and cannot be reversed through fiscal or monetary stimulus, investors generally regard Japan’s economic slowdown as structural rather than cyclical.

Meanwhile, Japan’s public debt has exceeded 250% of gross domestic product (GDP), the highest among advanced economies. Although most of this debt is domestically financed, keeping short-term risks manageable, such a heavy debt burden means that any significant rise in interest rates would sharply increase government borrowing costs. Consequently, even in the face of a weakening yen, the BOJ has limited scope to tighten monetary policy aggressively. Low interest rates help preserve fiscal sustainability but simultaneously encourage capital outflows, creating a long-term cycle that further weakens the yen.

As a result, neither interest rate hikes nor foreign exchange intervention are likely to alter the yen’s long-term trajectory. History shows that only an improvement in economic fundamentals can sustainably strengthen a currency. Otherwise, official intervention can do little more than smooth short-term volatility without reversing the underlying trend.

In the past, Japan relied heavily on its substantial merchandise trade surplus to support the yen. Rising exports meant that overseas buyers continuously purchased yen, driving the currency higher.

Today, although Japan continues to run a current account surplus, the composition of its income has changed significantly. An increasing number of Japanese multinational companies have shifted production overseas, with returns on foreign investments overtaking merchandise exports as Japan’s largest source of foreign exchange earnings. At the same time, rising energy imports have eroded the traditional trade surplus. Japan remains one of the world’s largest creditor nations, but this advantage no longer translates as naturally into sustained appreciation of the yen as it once did.

Rebuilding industrial competitiveness is the key

If the yen’s weakness stems from structural problems, then the solution must likewise be structural.

What Japan truly needs to restore is not its exchange rate, but its productivity, technological innovation and industrial competitiveness. Only by improving productivity and strengthening long-term growth prospects can Japan attract capital back and allow the yen to appreciate naturally. Industrial policy has therefore become not merely an economic policy, but a national strategy.

Priority sectors include artificial intelligence (AI), semiconductors, advanced robotics, industrial automation, advanced materials, defence technology and next-generation digital infrastructure. The objective is not only to revitalise manufacturing but also to re-establish Japan’s leading position in global technological competition.

Japanese Prime Minister Sanae Takaichi has proposed a 14-year public-private investment programme worth 370 trillion yen, across 17 strategic industries and 62 key products. Unlike Abenomics, which focused on monetary easing and demand-side stimulus, Takaichi places greater emphasis on supply-side reform and long-term industrial investment. Her aim is to rebuild Japan’s manufacturing capabilities, strengthen supply chains, enhance technological self-reliance and integrate industrial policy more closely with national security.

This strategy reflects a broader shift in Japan’s industrial policy — from prioritising efficiency and the lowest possible costs, towards emphasising economic resilience, technological sovereignty and economic security.

At the same time, China’s rapid advances in manufacturing, technological capability and supply chain influence have become a major catalyst for Japan’s industrial restructuring. Tokyo is not seeking comprehensive decoupling from China. Rather, while maintaining economic and trade cooperation, it aims to reduce dependence on any single supply chain, reflecting the international emphasis in recent years on “de-risking”.

Multiple challenges to success

Despite the ambition of Takaichi’s industrial strategy, its success will depend on several key factors.

First, Japan’s demographic structure remains its greatest constraint. By 2030, the country is expected to face a labour shortage of around 6.4 million workers, with an increasing scarcity of engineers and technical professionals needed for high-tech industries. Unless automation, AI and robotics significantly raise productivity, or immigration policies are moderately relaxed, labour shortages will remain the principal bottleneck to industrial revitalisation.

Second, financing pressures cannot be ignored. More than half of the 370 trillion investment programme depends on private capital. With government debt already exceeding 250% of GDP, there remains considerable uncertainty over whether such a large-scale investment programme can be sustained over the long term.

Third, industrial upgrading requires more than a decade of sustained investment, yet Japan’s democratic political system offers only limited policy continuity. Should future governments alter policy direction, the effectiveness of these investments could be undermined.

Japan must also contend with intense competition from Chinese companies. China has already established significant economies of scale and comprehensive supply chains in sectors such as electric vehicles, batteries, shipbuilding and advanced manufacturing. Although Japan’s efforts to diversify supply chains may enhance economic security, they could also increase business costs and weaken competitiveness. Balancing security and efficiency is one of the central tests facing Takaichi’s industrial strategy.

At the same time, Japan’s international environment has also become more complicated.

A more complex international environment

During the Biden administration, Japan’s industrial policy closely aligned with Washington’s strategy of restructuring global supply chains and reducing dependence on China. However, with the second Trump administration placing greater emphasis on stabilising US-China relations, Japan can no longer assume that the US will provide comprehensive support on every issue affecting Japanese interests. In future, Tokyo will have to take greater responsibility in safeguarding its own economic security.

Meanwhile, the Takaichi government’s relatively hawkish position on Taiwan has added further uncertainty to Sino-Japanese relations. China retains the ability to exert influence over Japan through economic instruments such as rare earth exports, investment, tourism and supply chains.

Consequently, while continuing to deepen the US-Japan alliance, Japan is also actively diversifying its partnerships by strengthening cooperation with Europe, Australia, India and Southeast Asia. As Japanese companies continue expanding their investments in Vietnam, Indonesia, Malaysia, Thailand and the Philippines, ASEAN’s strategic importance is set to grow further.

The weakness of the yen is not merely an exchange rate issue, but a concentrated manifestation of Japan’s structural economic challenges. Population decline, stagnant productivity, fiscal constraints, changes in the composition of overseas earnings, and intensifying global technological competition have together undermined the foundations that once supported a strong yen. Consequently, neither interest rate hikes, monetary tightening nor foreign exchange intervention are likely to reverse the long-term trend fundamentally.

From this perspective, Takaichi’s industrial strategy is not primarily intended to strengthen the yen directly. Rather, its true objective is to restore Japan’s long-term economic competitiveness by rebuilding advanced manufacturing, enhancing technological innovation, strengthening supply chain resilience and developing strategic industries. If productivity continues to improve, industrial competitiveness recovers and international capital flows back into Japan, a stronger yen will emerge as the natural outcome of economic renewal, rather than as a policy goal pursued for its own sake.

Whether this strategy ultimately succeeds, however, remains uncertain. Population ageing, fiscal pressures, policy continuity and international competition could all limit the effectiveness of the reforms. Nevertheless, Takaichi’s policies have at least redefined Japan’s central challenge: what truly needs rebuilding is not the yen itself, but the innovation capacity, industrial strength and economic vitality that underpin its value.

This article was first published in Lianhe Zaobao as “日元疲弱：结构性挑战与产业振兴之路”.

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