The Yen Paradox

By most conventional logic, Japan should have a strong currency. It doesn’t. Working out why is one of the more useful lessons available in currency markets today.

Japan is the world’s fourth-largest economy, a leader in advanced manufacturing and semiconductor equipment, and the destination behind a record 42.7 million tourist visits in 2025. By the usual “strong economy, strong currency” logic, the yen should be riding high. Instead, it’s trading near 40-year lows against the dollar, and by one measure of real purchasing power — what it actually buys abroad, not just its exchange rate — it hasn’t been this weak since the early 1970s.

None of this is a blip. It’s the outcome of several structural forces that have quietly reshaped how the yen behaves, and almost none of them have much to do with whether Japan’s economy is doing well or badly.

01 — Interest RatesSame Yen, Different Address

For decades, the Bank of Japan held interest rates near zero to fight deflation. That changed in March 2024, with its first hike in 17 years — and the yen kept falling anyway.

The reason lies in real interest rates, not the headline figure. Even after repeated hikes, Japan’s inflation-adjusted rate has stayed deeply negative — around −2.15% by December 2025 — while the US real rate sat near +1.44%. A gap that size keeps the “yen carry trade” alive: borrow cheap yen, buy higher-yielding dollar assets, repeat. And because the trade is leveraged, it can unwind just as fast as it builds. In August 2024, a rapid unwind sent the yen up 12% in three weeks and dragged the Nikkei down 12.4% in a single session — its worst one-day drop since 1987. Japan’s economy hadn’t suddenly improved. Leveraged positions had simply come undone all at once.

A fair question is why the BOJ doesn’t just close the gap faster. The honest answer is that it can’t, not without a cost most policymakers would rather avoid. Japanese government debt sits at roughly 230% of GDP — among the highest of any developed economy — and every rate hike raises what the government itself pays to service that debt. The BOJ is left balancing a weak currency against a debt load that punishes it for moving too quickly. That tension, more than indecision, is why the gap has persisted as long as it has.

02 — Current AccountA Record Surplus That Never Comes Home

Here’s the part that trips up even professional forecasters: Japan posted a record current account surplus in FY2024 — and the yen kept falling anyway.

Two decades ago, that surplus came from trade: cars and electronics sold abroad, converted back into yen. Today the trade balance is often in deficit, and the surplus instead comes almost entirely from primary income — interest and dividends on Japan’s $3.5 trillion pile of overseas investments, the largest of any country on earth. The catch is that most of that income stays abroad, reinvested into the same overseas operations that earned it, rather than converted back into yen. Japan is earning more from the world than ever. The money simply isn’t coming home.

03 — Household SavingsSavers Are Leaving Too

Japanese households are doing something similar with their own money. A 2024 overhaul of Japan’s tax-free investment scheme, NISA, triggered a surge into foreign stocks and funds. Nomura estimates the shift accounted for roughly half of the dollar’s rise against the yen that year. With more than half of Japan’s ¥2,000 trillion in household financial assets still sitting in near-zero-yield yen deposits, even a modest move abroad shifts a very large sum of money — quietly, one retirement account at a time.

04 — The Demographics MythBlame Productivity, Not Population

The most popular explanation for Japan’s stagnation is its aging, shrinking population. It’s a real challenge — but recent economic research suggests it isn’t actually the main driver, and the distinction matters for anyone thinking about Japan’s currency long-term.

A growth-accounting exercise spanning seven decades of Japanese data makes the case with hard numbers. During the 1955–75 boom, when Japan grew 7–8% a year, demographics contributed barely one percentage point of that growth — productivity did essentially all the rest. In the recent stagnation, the story runs the same way in reverse: demographic drag has been minimal to nonexistent over the past decade, since rising participation from women and older workers has largely offset the shrinking population, while productivity growth is what collapsed.

The thing that made Japan grow fast, and the thing that made it stop, is mostly the same variable — and it isn’t the birth rate.

05 — What’s LeftTourism, Chips, and Politics

Record tourism and a wave of new semiconductor investment — TSMC’s Kumamoto fabs among them — are real, and the weak yen directly caused both. But their scale, however record-breaking, keeps getting dwarfed by the structural outflows described above.

The newest complication is political. In mid-2026, an early draft of Japan’s fiscal blueprint was read by markets as pressure on the Bank of Japan to go slow on rate hikes, and the yen sold off on the perception alone, before any policy actually changed. By now, the yen’s story is as much about institutional credibility as it is about arithmetic.