on the dollar-yen exchange rate
=economics
Recently, the yen-dollar exchange rate hit a 34-year low. Why is that?
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6-month US Treasuries are paying
around 5.3% interest. Japanese government bonds are paying about 0%. That
being the case, you can borrow yen, trade it for dollars, buy US bonds, and
get more interest. That's called a "yen carry trade". The risk you take in
exchange for that money is that the exchange rate will shift so that a
dollar is worth less yen.
But of course, it's also possible that the
exchange rate will shift in the other direction, and that's what's happened
recently. From 2020 to now, $1 went from 105 to 150 yen.
That being
the case, I'd normally expect inflation to be higher in Japan than the US -
their currency became less valuable, which makes imports more expensive.
Yet, that's not what happened; inflation has been higher in the US. In
Japan, you can get a good bowl of ramen for $6. In an American city, today,
including tax and tip you'd probably pay more like $20 for something likely
worse.
The PPP / nominal GDP of Japan is now ~1.5x that of the US,
and I'd argue that's actually an underestimate: PPP estimates don't account
for *quality of services*, and a lot of Japanese services are higher-quality
than their US equivalents. But that's not to say I envy how the economic
situation of people in Japan has changed. While inflation was lower in Japan
than America, wages barely increased, and real incomes of most Japanese
fell.
In some countries, you can argue that crime or lack of property
rights or inadequate infrastructure keep labor values down, but that's not
the case for Japan. So, we're left with some questions.
Question 1: Why would an hour of labor from an
American be worth 2x as much as an hour from a Japanese employee?
I remember talking to an economist about this once, and he
said, "that means Japanese labor is just not as good as American labor" -
but he was just wrong. (He didn't even consider the possibility that
Japanese management culture was the problem, because obviously inefficient
companies would just get outcompeted.) There's something about a lot of
economists where, when they have some model and reality disagrees with them,
they seem to think reality is wrong, and aren't even inclined to
investigate.
I'll have to get back to this later.
Question 2: Why do Japanese automakers operate
some factories in America instead of importing everything from Japan?
I can answer this one:
- Direct
labor is generally <20% of the cost of a car, and a lot of components can be
imported from other countries.
- Shipping a car to the US from Japan
costs maybe $1000.
- For US imports from Japan, there's a 2.5% tariff on
cars and 25% on trucks. Trucks make up the majority of Ford's profits; they
basically can't make a profit when competing with Japan with no tariff.
-
Most of the US factories were built decades ago, and new factories are being
made in Mexico instead.
Question 3: Why can the Japanese government keep
borrowing money with no interest?
That debt is funded
largely by bank deposits from Japanese citizens. I asked a Japanese guy I
know why people don't put their money in something that yields more
interest, like US bonds, and he said:
Japanese people think of investments as having risk, and bank deposits as being safe. They don't really understand that their bank deposits aren't inherently safer than some other things.
Question 4: If dollars are overvalued, why does
America have any exports?
A lot of US exports are
currently oil and gas products, which are natural resources being used up. I
personally think the US government should tax the extraction of natural
resources, because they have some value that should be collectively owned by
the population, but that's another topic.
How about food exports?
Some farm crops are subsidized, and the US has a lot of good farmland, but
maybe the farmer subculture that the US has is particularly competent.
Boeing exports planes, but note:
- Some
components are imported, ~30% for the 787.
- The manufacturing of Boeing
planes is largely in lower-density areas with lower wages. Their factories
and US suppliers have lower wages than the US average.
New drugs, movies, and software have low marginal costs relative to their development costs. It's possible that development of them would be cheaper if it was moved to another country, but moving complex institutions to another country is difficult. Still, relying on institutional inertia isn't a good long-term economic plan - these days, Yandex and Baidu can do search as well as Google, Genshin Impact makes as much money as the entirety of EA, Tencent owns Riot Games, American movies are losing popularity in China, and TSMC's semiconductor production is ahead of Intel.
Question 5: If American labor is expensive, what's
it doing?
Rents are set by what people can pay. Wages
are set by people's other options. If paying Americans to work in factories
or do welding or whatever is too expensive, what are Americans doing
instead? The answer is "services". But everyone working as DoorDash delivery
and childcare for everyone else doesn't work. Indeed, DoorDash workers don't
make enough to get their food from DoorDash, and cooks at restaurants don't
make enough to eat out at restaurants much.
Those services only make
sense economically if they're for richer people than the workers. The lower
class cooks and delivers food for the middle class, which provides
administration and luxury services, and at the top of a pyramid of services
is wealthy people who own the factories that produce stuff and some of the
houses that poorer people live in. NYC and London have high average incomes,
but they don't produce and export physical stuff; their main role is to
provide luxury services to the people who provide luxury services to the
wealthy people who own stuff elsewhere. In an egalitarian society, the same
group of people both produces and uses goods, but the income and wealth
inequality in America today has led to more stratification.
Question 6: Why do people want dollars if they're overpriced?
One reason is to buy stocks. The US stock market has
gone up a lot, while the Nikkei 225 and Shanghai Composite Index have been
flat for decades, despite Chinese economic growth. Investors in public stock
markets seem to capture more of the economic value of companies in America.
And foreign ownership of US stocks has increased greatly over the past few
decades.
Another reason is to buy Treasuries. At current rates, the
short-term ones aren't bad - I own some myself! In theory, the economic
system is supposed to get people to put their money in whatever the best use
for it is. Do I think whatever the US government does with my money is the
most-productive use for it? No, at this point I think of Treasuries as more
of a very slow Ponzi scheme, with plenty of bagholders (people with bank
deposits getting invested in 20-year Treasuries) in front of me if things
ever go bad. If a groups is continuously borrowing lots of money, it should
be investing that money in productive assets to pay back those loans, but
that's not what I see happening.
Then there are the exports mentioned
above, but imports are substantially greater - and if anything, I think US
imports are underestimated, because of companies overvaluing final assembly
of imported components in order to meet "made in the USA" labeling
requirements.
Question 7: Is that actually a problem?
So, suppose the US totally deindustrializes, and can buy all its stuff
from China, while putting all its efforts into a pyramid of luxury services,
education, and medical treatment. Is that a problem? Well, when I put things
in an exaggerated way like that, maybe it does sound like a problem. But
what exactly are the issues?
- The US is
selling debt and assets over time, and that's not sustainable forever.
-
Doing engineering produces knowledge externalities, more so than waiting
tables or financial engineering. Engineers learn things from doing their
jobs, and they sometimes switch companies, usually staying in the same
country, so companies aren't capturing as much value from local
manufacturing as their host country is.
- Goods and services that require
expensive infrastructure or extensive training tend to have higher consumer
surplus, because they're less substitutable by the consumer's labor. Cooking
instead of going to a restaurant isn't a big deal, but if you can't buy
computer parts, you won't be making them yourself. This is true for
companies as well as individuals, and the network of eg electronics
suppliers in Shenzhen is important.
The last 2 points, while apparently too difficult for some economists to understand, can justify some tariffs or export subsidies, and governments seem to agree. But of course, government subsidies are decided politically. The best you can realistically hope for is a set of special interests that collectively push in mostly-positive directions.
Question 8: Why don't Japanese invest domestically?
I already answered that, right? It's because the Nikkei has been
flat. But why is that?
An answer I've often seen is that Japanese
stocks haven't done well because the Japanese economy and population haven't
grown, but I don't consider that a good answer. For one thing, the Shanghai
Index also being flat indicates that other factors could be involved. But
more importantly, companies have at least as many investment options as
individuals: if people invest in Japanese corporations that can't find
domestic investments, those corporations could buy US stocks as well as
their investors could. Banks own stocks, and Apple used to own $50 billion
of Treasuries.
So, if returns on US stocks seemed better than
investment inside Japan, companies could have bought those instead, and they
should be about as informed as their investors, but companies also have
extra investment options. For example, Japanese car companies could open
factories in other countries - and they did!
The Nikkei 225 has given
out dividends, so the flat price is slightly misleading, but they weren't
really higher than S&P 500 dividends. So that's not a good explanation
either.
One hypothesis is that Japanese companies just collectively
failed to invest in projects with positive returns on average. They
definitely invested in productive projects, so in that case there must be
proportionate waste, but I don't see that. Another hypothesis is that
returns existed and were shifted somewhere, probably by self-dealing to
privately owned companies. What would that look like, and why might it
happen more in Japan than America?
Profit shifting from corporations
isn't a new concept; 150 years ago railroad companies were screwing over
investors by hiring other firms controlled by management at inflated rates,
famously including the
Crédit Mobilier scandal.
Such scandals led to more regulation of US corporations, but the oversight
and transparency requirements for corporations in Japan are weaker. Of
course, US corporations are still doing profit shifting on a massive scale,
such as the Double
Irish scheme where
corporations pretend some IP was developed in Ireland and pay their Irish
subsidiary for it, but it's technically legal. I actually know an engineer
involved in the Toshiba-Westinghouse Vogtle nuclear plant project who told
me about how money was leaking and executives had to be involved.
Another difference between Japanese and US corporations is that US
executives move between companies more. Japanese execs tend to stay in the
same company and move up at the same rate, which gives more time for
personal relationships and private deals to develop.
As for plausible
total amounts of money, well, the
Panama
Papers covered $2 trillion of
offshore transactions, which was largely legitimate activity but also only
one law firm. The ICIJ estimates that the total global amount of money held
offshore is between $5.6 trillion and $32 trillion. In China's case, of
course, returns would be siphoned mainly by the government instead. Money
siphoned from corporations by self-dealing wouldn't necessarily be offshore,
but I think it mostly would be.
Japanese corporate
financial
scandals
have been more about pretending a company had more money than it did, but
that's easier to find out than self-dealing, and that fraud still took a
while to be exposed.
Jack Welch made money by cutting long-term
investment in ways opaque to investors to make GE stock go up temporarily.
With Japanese executives who have long tenures, good investments are still
good investments; what I'd expect with self-dealing is increased debt rather
than decreased investment. It's true that Japanese companies have had a
much higher debt-equity
ratio than US ones. Large UK companies
have had debt-equity ratios and stock returns between US stocks and Japanese
stocks. Economically I'd expect companies to prefer to borrow more when
stock returns are high, but across countries we've seen the opposite
instead.
The US has
about the same median wealth per
adult
as Japan and some European countries, but much higher average wealth, about
5x the US median. If,
hypothetically speaking, those countries had a comparable Gini coefficient
to the USA but the wealth was better hidden, their net wealth per capita
would be similar to the USA. I don't think that's plausible, but it could be
directionally correct.
Question 9: Why don't foreign companies outcompete
in Japan?
If big Japanese companies are all leaking
money or all can't invest well, either way, foreign companies should be able
to outcompete them, right?
There are obvious language barriers and
cultural differences, and that is a problem, but that didn't prevent
Japanese firms from opening factories in America and various other countries
in the past. I think the main problem is the government making it hard for
foreign firms to operate there, but if anything, it's more fair to foreign
firms than South Korea, which actually has a higher PPP GDP than Japan now.
Question 10: What could be done about these
issues?
Regarding self-dealing in Japanese companies:
- Disclosing
the owners of private corporations is a start. Japan established new
regulations about this in 2018 to meet FATF international agreements.
-
Random audits of payments from large corporations to private companies,
weighted by payment sizes.
Regarding failure of companies to
make investments with positive returns, that would mean the entire corporate
system is a failure and a different way to choose company management would
be needed.
Regarding
failure
of US companies to make long-term investments, the current "solution" is
more private ownership of companies, and privately companies have had higher
returns lately. The WSJ recently
had an
article
saying "Private-sector investors are so ineffective at overseeing companies
that state-run funds feel the need to step in" - so I guess that's an
option: governments could grant government-run investment groups the votes
of index funds from that country. That's not how things were originally
meant to work, but neither is an aristocratic "board-member class"
appointing itself to control of the economy.
Question 11: What if you're an American who wants
to make stuff?
I live in America, and my skills are
largely related to design and production of physical stuff, so I've thought
about this question a while, and I have a metaphor that I think clarifies
the problem.
Imagine you live in a billionaire's huge mansion, and
you're hired by the maids to fix their food. The billionaire in residence
owns assets elsewhere, but is also mortgaging the building and furniture to
pay for stuff. There are tailors who make clothes for people in the mansion,
but the costs and prices of those clothes are higher than the clothes
outside the mansion. A tailor says to you, "I'd like to try making some of
the {thing} this house imports, but it's expensive to do that here. What
should I do?" The usual answer is, of course, to leave that house to make
the {thing}. A 2nd option is to try to interest the billionaire in your
project, and cater to their whims if they decide to make manufacturing
{thing} a hobby of theirs. A 3rd option is to be so much better at making
{thing} than people elsewhere that you can compete despite higher costs,
perhaps by getting enough money from the billionaire to do things on a
bigger scale, or perhaps by them using political influence to block
competition. A 4th option is to act as a liason for the billionaire
establishing production facilities outside the house.
If you're not
in a position to make such deals with the billionaire of the house, then
your only option of those is the 1st one. But if you move to another
country, apart from potentially bringing more money than most people have,
or potentially having support (such as preferential hiring or investment)
from other people from your original country, you'll be at a disadvantage
relative to native citizens.
Within a country, the above metaphor is
more apt in some places than others. It's more accurate in London or NYC
than in a smaller town supported by a factory or mining. When companies do
open factories in America, they try to do that in places unlike NYC:
locations with a low cost of living where the factory can go right next to a
highway. Within that metaphor, this could correspond to finding some remote
corner of the mansion (relatively far away from the billionaire owner) to do
your manufacturing in. Or maybe that would be outside the mansion but
nearby? I'm not a metaphor specialist.
For a government that doesn't
like that dynamic, a possible response is to heavily tax luxuries (and
perhaps types of administration/lawyer/etc spending that increase control
but not societal wealth), use capital controls to prevent the wealthy from
sending their money somewhere with lower taxes, and use that tax revenue to
directly fund domestic investment. This isn't a wild hypothetical: China's
government has a notoriously high luxury tax, strict capital controls, and
directly funds domestic investment in manufacturing. (In 2010, luxury tax
revenue supposedly funded 78% of the central government's spending.) But in
America, presumably, the government wouldn't attempt such actions, and
judges would block them if it did.