Japan's Yen Crisis and China's Export Shock: Why Currency Wars Are Back

The yen's decline to 1970s purchasing power levels signals intervention fatigue while China's export volumes surge 10% despite price wars, creating new global trade tensions.

Brad Setser explains how extreme currency movements and Chinese excess capacity are reshaping international trade dynamics and financial interdependence.

Key Takeaways

• Japanese yen weakness reaches extreme levels equivalent to early 1970s purchasing power before Japan's export dominance emerged
• China's export volumes up approximately 10% despite falling prices, driven by excess capacity from property market collapse
• Chinese companies now dominate global excavator exports as construction equipment capacity shifts from domestic to international markets
• Currency movements still matter for trade competitiveness despite technological advantages, with weak yuan contributing to export boom
• Financial interdependence creates asymmetric vulnerabilities where China's real goods leverage exceeds US financial asset advantages
• Japanese intervention strategy aims to set floor around 150-154 yen per dollar rather than reverse overall weakness trend
• Korean auto exports surge demonstrates currency weakness transmission to trade volumes in manufacturing sectors
• China's steel exports now exceed total US and Japanese steel production combined, indicating massive excess capacity potential

Timeline Overview

• 00:00–08:15 — Yen Intervention Analysis: Japanese Ministry of Finance intervention temporarily moved yen from 160 to 152 but weakness resumes toward intervention trigger levels
• 08:15–18:30 — China Export Surge Context: Export data shows 1.5% dollar growth but 10% volume growth due to falling prices across key sectors
• 18:30–32:45 — Currency Wars Revival: Traditional relationships between exchange rates and export competitiveness reasserting despite technological factors
• 32:45–45:20 — Excavator Economics: Chinese construction equipment exports exemplify excess capacity redirection from domestic property collapse to global markets
• 45:20–END — Financial Interdependence Asymmetries: Real goods dependence creates different leverage dynamics than traditional financial asset relationships

Japanese Yen Weakness and Intervention Strategy Limitations

The Japanese yen has reached extreme weakness levels that restore purchasing power equivalent to the early 1970s, before Japan's electronics industry and automotive export success established its modern economic position. This represents a fundamental disconnect between Japan's underlying economic strength and its currency valuation, driven by persistent interest rate differentials with the US and Europe.

• Real exchange rate weakness returns Japan to purchasing power levels from before Toyota's global expansion and electronics industry dominance
• Ministry of Finance intervention moved yen from 160 to 152 but currency drifting back toward intervention trigger levels
• Intervention strategy focuses on setting floor around 150-154 range rather than reversing overall weakness trend
• Bank of Japan maintains accommodative policy despite currency pressure, prioritizing domestic inflation targets over exchange rate stability
• Weak yen increases import costs for energy and food while reducing real wages for Japanese workers over two-year period
• Limited transmission from export company profits to domestic wage growth undermines reflation strategy effectiveness

The intervention approach acknowledges that fighting massive interest rate differentials requires unsustainable foreign exchange reserve depletion. Instead, Japanese authorities attempt to manage the pace of decline while hoping for eventual Fed policy accommodation that would reduce pressure on the yen.

China's Export Volume Boom Behind Price War Headlines

Chinese export data reveals a more dramatic story than headline dollar growth figures suggest, with export volumes increasing approximately 10% while prices fall significantly across key sectors. This combination of volume growth and price decline indicates intense competitive pressure as Chinese companies redirect excess capacity from weakened domestic markets toward international expansion.

• Export volumes up roughly 10% despite headline dollar growth of only 1.5% due to systematic price reductions
• Electric vehicle price wars, solar panel competition, and battery manufacturing creating deflationary export pressure
• Chinese automotive sector transformed from luxury import market to world's largest car exporter within five years
• Clean energy exports including solar panels and batteries operate with enormous domestic capacity exceeding global demand requirements
• Traditional manufacturing exports also increasing as companies redirect production from domestic property-related demand
• Yuan weakness of approximately 10% in real terms supports export competitiveness alongside technological advances

The export surge reflects structural shifts in Chinese industrial capacity rather than cyclical trade fluctuations. Companies built massive production capabilities during the domestic property boom now seek international markets as domestic construction demand collapses.

Currency Competitiveness and Traditional Trade Relationships

Despite arguments that technological advantages supersede currency effects in modern trade, traditional relationships between exchange rate movements and export competitiveness are reasserting themselves across multiple countries. Korean auto exports demonstrate clear responsiveness to won weakness, while Chinese export success combines both technological capability and currency competitiveness.

• Korean auto exports to US increased substantially following won weakness, contradicting technological-only competitiveness theories
• Japanese exporters like Toyota prioritize profit margins over volume response to yen weakness, limiting traditional transmission mechanisms
• Chinese yuan weakness below 15-year historical levels contributes to export competitiveness alongside manufacturing improvements
• General rule that non-appreciating Chinese currency correlates with global market share gains continues to hold
• Real exchange rate movements through inflation differentials amplify nominal currency effects on trade competitiveness
• Currency weakness helps convert excess domestic capacity into internationally competitive export production

The reassertion of currency effects challenges views that modern trade depends primarily on technological advantages and supply chain positioning. Exchange rate movements continue to influence relative costs and export pricing strategies across traditional and advanced manufacturing sectors.

Chinese Excavator Exports as Excess Capacity Symbol

Construction equipment exports, particularly excavators, exemplify how Chinese excess capacity from the property market collapse redirects toward global markets. Chinese companies that gained domestic market share during the construction boom now export competitive equipment as domestic demand collapses, creating pressure on established international manufacturers.

• Chinese excavator manufacturers gained domestic market share against foreign competitors like Caterpillar and Komatsu during property boom period
• Construction equipment capacity built for domestic market now redirected to international exports as property development contracts
• Excavator exports represent broader pattern of construction-related industrial capacity seeking global markets
• Chinese companies offer competitive pricing including $2,000 excavators available through platforms like Alibaba
• Construction equipment follows similar pattern to steel exports where Chinese capacity exceeds individual country production levels
• Excess capacity potential extends beyond current export levels with room for significant further expansion

The excavator example demonstrates how China's property market legacy creates ongoing trade tensions. Industrial capacity built for domestic infrastructure cannot be quickly eliminated, creating sustained export pressure in multiple construction-related sectors.

Steel Export Capacity and Industrial Overcapacity Scale

Chinese steel exports now exceed the total production of major steel-producing countries, illustrating the massive scale of potential export capacity across industrial sectors. This capacity represents ongoing trade tension potential as Chinese companies can significantly expand exports without approaching production limits.

• Chinese steel exports exceed total US steel production and Japanese steel production combined
• Current steel export levels do not exhaust Chinese export capacity with significant room for further expansion
• Automotive export capacity could increase from current 5 million vehicles to 10 million, exceeding Japan and Germany
• Construction-related materials including steel, construction equipment, and components redirecting from domestic to international markets
• Forward-looking concern about potential export expansion creates nervousness among China's trading partners
• Capacity utilization rates allow for substantial export increases without requiring new production investment

The scale of Chinese industrial capacity creates asymmetric trade relationships where relatively small shifts in domestic demand can generate large international export increases. This dynamic makes China's trading partners vulnerable to sudden competitive pressure without corresponding adjustment time.

Financial Versus Real Economic Interdependence Asymmetries

The relationship between financial and real economic interdependence creates asymmetric vulnerabilities where China's control over real goods flows may provide more leverage than traditional financial asset relationships. Chinese export surpluses no longer automatically translate into Treasury purchases, reducing US financial leverage while maintaining Chinese goods market power.

• China shifted from direct Treasury purchases to diversified foreign exchange reserve usage reducing visible financial interdependence
• Private sector accumulation of foreign assets replaces central bank Treasury purchases as export financing mechanism
• Chinese economy's low foreign currency debt and trade surplus reduces vulnerability to financial asset freezing
• US economy's dependence on Chinese manufactured goods creates vulnerability to supply disruption
• Import component dependence means alternative sourcing often requires other Chinese suppliers rather than non-Chinese alternatives
• Financial sanctions proven less effective against economies with trade surpluses and minimal foreign currency obligations

Financial interdependence weaponization through sanctions and asset freezes may prove less effective against China than real economic leverage through export restrictions. China's preparation for reduced external dependence includes commodity stockpiling and import substitution strategies.

Strategic Decoupling and Dependency Vulnerabilities

China's strategy of reducing dependence on manufactured imports while maintaining export market access creates asymmetric vulnerabilities where external markets become more important for Chinese employment while China becomes less dependent on foreign suppliers. This shift changes traditional trade interdependence dynamics.

• Chinese strategy aims to substitute domestic production for manufactured imports while expanding export capacity
• Commodity stockpiling and domestic production reduces vulnerability to import disruption
• Growing Chinese export dependence creates vulnerability to market access restrictions
• Excavator and automotive workers increasingly depend on export market access for employment
• Import substitution for manufactured goods reduces leverage of traditional trading partners
• Export market dependence grows as domestic property and infrastructure demand contracts

The strategic decoupling creates a transition period where traditional interdependence relationships break down before new equilibria establish. China's reduced import dependence for manufactured goods occurs alongside increased export market dependence for employment.

Common Questions

Q: Why doesn't Japanese yen intervention reverse the overall weakness trend?
A: Interest rate differentials remain too large for intervention to overcome without unsustainable reserve depletion.

Q: How do falling export prices indicate Chinese competitive strength?
A: Volume growth of 10% despite price declines shows Chinese companies gaining market share through competitive pricing.

Q: Do currencies still matter for trade competitiveness in advanced manufacturing?
A: Yes, Korean auto exports and Chinese export success demonstrate traditional currency effects remain important.

Q: What makes Chinese excavator exports significant beyond construction equipment?
A: They exemplify how excess capacity from property market collapse redirects toward global export pressure.

Q: How does financial interdependence differ from real economic dependence?
A: Financial asset freezing affects countries with foreign debts while real goods disruption affects import-dependent economies.

Conclusion

The simultaneous emergence of extreme yen weakness and Chinese export expansion demonstrates how currency movements continue to influence global trade patterns despite technological advances and supply chain complexity. Japan's intervention strategy acknowledges the futility of fighting massive interest rate differentials while attempting to manage the pace of currency decline through tactical market operations. Meanwhile, China's export surge reflects the redirection of massive industrial capacity built during the property boom toward international markets, creating sustained competitive pressure across multiple manufacturing sectors.

The traditional relationship between currency weakness and export competitiveness reasserts itself as Chinese companies combine technological capabilities with real exchange rate advantages to gain global market share. These dynamics challenge established frameworks for understanding financial versus real economic interdependence, as China's control over manufactured goods flows potentially provides more leverage than traditional financial asset relationships in an environment where interdependence itself becomes weaponized.

Practical Implications

• Japanese companies should hedge yen exposure while considering domestic wage pressures from import inflation in strategic planning
• International manufacturers must prepare for sustained Chinese competitive pressure across construction equipment and automotive sectors
• Currency hedge strategies should account for intervention patterns that manage decline pace rather than reverse weakness trends
• Supply chain managers need alternatives to Chinese components given potential for trade disruption beyond current tariff measures
• Financial institutions should evaluate exposure to economies with large foreign currency debts versus trade surplus countries in crisis scenarios
• Infrastructure investors must consider excess capacity dynamics when evaluating demand projections for construction-related commodities
• Export-dependent companies should diversify market access to reduce vulnerability to single-country trade restrictions

Currency wars have returned as monetary policy divergence creates extreme exchange rate movements that traditional trade relationships cannot ignore, requiring updated strategies for managing competitive displacement and supply chain vulnerabilities.