Why the Yen is the Most Undervalued Currency
The fact that the yen have fallen more than 10% against the dollar is pretty amazing given the fact that during the same period the U.S. consumer price index have risen about 20% while the Japanese consumer price index have in fact fallen somewhat. And while price inflation have been somewhat lower in the Euro zone than in America, it have not been sufficently lower to prevent the real appreciation of the euro from being even greater than the dollar's.
As a result of this, Japan have been one of the few industrialized economies who have seen its current account surplus rise, despite the rising surpluses of China and the world's oil exporters. America by contrast have seen its already large deficit increase further, whereas the Euro zone have seen its previous surplus wiped out and turned into a deficit.
One would have actually expected Japan's surplus to fall, if not disappear completely given the extremely large budget deficit and the downward pressure on private savings created by an aging population and very low interest rates. But the sharp real depreciation of the yen have apparently more than offset these effects.
While a slight gradual real depreciation could perhaps have been expected given the structural downward pressure on land prices (and therefore by extension cost of living) created by Japan's shrinking and aging population, clearly the decline we have seen in recent years have been far, far greater than what could possibly be motivated by that structural factors.
The fact that the yen have depreciated in real terms far more than could have been expected from structural factors while the Japanese current account surplus have continued to rise even though one could have expected it to fall based on structural factors clearly show that the Japanese yen is the most undervalued currency around right now, together with the Swedish krona (I'll return to the Swedish krona in a later post).
Note however, that when I write that the yen is the most undervalued currency, that does not necessarily imply that it will be the currency which gains the most. Currencies can often deviate greatly from their fair value for a long period of time and undervalued currencies often get even more undervalued before they become less undervalued.
As long as the gap in interest rates remain or widen further, the yen could continue to be undervalued or even become even more undervalued. When interest rates differentials start to fall, the yen should start rising significantly, although likely not dramtically as the Bank of Japan is unlikely to tolerate that.