In order to boost exports, Japan expects to maintain the RMB and dollar exchange rates against the Japanese yen.

With a deepening American national debt and a weakening U.S. dollar, voices from various countries are getting louder day after day demanding a reduction in their nation’s hold on the American debt. Only Japan maintains its grip on the American national debt with “firm confidence”

On June 15th, the American Ministry of Finance published data that confirmed the Japanese policy (to continue to hold U.S. national bonds) is not just empty talk. Among major developed countries, (with the exception of the United Kingdom), most nations have opted to reduce their hold on American national debt beginning in April. Conversely, Japan only cashed in 800 million U.S. dollars of 685.9 billion USD, sufficiently demonstrating its support for American finances.

With the anticipated rise of inflation, the U.S. has encountered a worldwide sell-off in American debt. So what is the inherent logic behind Japan’s choice to retain its holdings?   

Actually, it is very simple: first, Japan's debt holdings are second in the world only to China. Second, a falling national debt price implies that assets are shrinking, which indicates that the U.S. dollar demand is weakening and that the Japanese Yen relative to the US dollar is getting stronger. This shift in exchange rates will certainly have a negative impact on Japan’s export trade with the U.S.  

Currently the Japanese economy is still in an economic downturn. Although the fiscal stimulus scale is continuously expanding and is supplemented by flexible fiscal policy, this does not significantly boost the domestic demand. The employment forecast is similarly gloomy-many of the Japan’s core industries, such as the electronic manufacturing industry and the automobile manufacturing industry have, one after the other, been rocked by layoffs and wage cuts.

Simultaneously, the Japanese government’s usual wasteful spending has come under scrutiny and Japan has had no choice but to learn “frugal spending.”  

Fitch Ratings Ltd.–Asia Pacific sovereign ratings General Manager James McCormack indicated on June 15th that to resolve the finance revenue and expenditure issue, Japan may need to make “a difficult decision”.  

And the Japanese government must be particularly sensitive to these sovereign-rating alerts. After firms predicted the decline of British sovereign rating, this kind of warning is particularly potent and has forced Japan away from the possibility of expanded fiscal stimulus. With the need to boost Japan’s economy still ever-present, the only remaining economic hope lies in slowing down of the decline in export trade.

Among Japan’s U.S. export product types, mechanical, electronic and automobile equipment make up approximately 87% of the total product. From the perspective of the automobile and electronics exporters, due to the fairly large flexibility in price, any change in the exchange rate will undoubtedly have a significant influence on the competitive power of Japanese exports.

In April, Japanese industrial manufacturing grew 5.2%, a recovery linked closely with exports. The bounce-back industries including semiconductor and electronic products, chemical products, automobile equipment, plastic products and metal products.

At the same time, China’s role in invigorating Japan’s exports is becoming increasingly clear; competition from China has also become an important consideration for Japan in supporting the American national debt.

Following a reduction of interest rates by most of the world’s major developed economies, the low Japanese interest rate is no longer unique. Activity in the “carry trade” market has also increased in recent months; “carry trade” is a strategy that uses a certain currency with a relatively low interest rate to purchase another currency yielding a higher interest rate. This market has been attracting investors for a long period of time but the more recent influx of interest has greatly weakened the system.

Reducing the difference in interest rates means that the profit from “carry trade” has shrunk significantly. It seems unlikely that an investor would use the US dollar (now that the American interest rate has been reduced to near zero) to perform the same type of economic acrobatics.

Under these circumstances, Japanese Yen sell-offs would naturally be greatly reduced. The Yen’s appreciation is nothing unusual but in this kind of situation, the Japanese government is powerless; they can only passively accept.

All that is left to do is diligently support the US dollar, not only because Japan's export industry might come under attack, but also because the US dollar may soon replace the Japanese Yen as the first choice arbitrage tool in the financial world. If these assumptions stand, it means that until the Federal Reserve raises the interest rate, the Japanese Yen will continue to feel the pressure.