The yen was introduced by the Meiji government in 1870 as a system resembling those in Europe. The yen replaced the complex monetary system of the Edo period, based on the mon.
The mon was a currency of Japan until 1870, as there were hundreds of different styles of currency throughout Japanese history, of many shapes, styles, designs, sizes, and materials, including gold, silver, bronze, etc. Even rice was once a currency, the koku.
The yen lost most of its value during and after World War II; after a period of instability, the yen was pegged at 1 US dollar = ¥360 from April 25, 1949 until 1971 when the Bretton Woods system collapsed and the value of the yen began to float. After the Plaza Accord of 1985, the yen appreciated against the US dollar, until it reached a peak of about ¥85 per dollar in the mid 1990s. After that, the Bank of Japan adopted a weak yen policy which has held it in the range of ¥100-120 per dollar. In the last couple of years, the yen has grown weaker and weaker against not only the dollar but against nearly all other important world currencies due to a de facto zero interest rate policy which has encouraged massive yen carry trades, where speculators borrow in yen and buy bonds and other assets in currencies that charge significant interest. This can be very profitable, but is a short position on the yen, which in the absence of other factors drives the yen's value down.
Determinants of value
The relative value of the yen is determined in foreign exchange markets by the economic forces of supply and demand. The supply of the yen in the market is governed by the desire of yen holders to exchange their yen for other currencies to purchase goods, services, or assets. The demand for the yen is dependant on the desire of foreigners to buy goods and services in Japan and by their interest in investing in Japan (buying yen-denominated real and financial assets).
Fixed value of the yen to the US dollar
In 1949 the value of the yen was fixed at ¥360 per US$1 through a United States plan, which was part of the Bretton Woods System, to stabilize prices in the Japanese economy. That exchange rate was maintained until 1971, when the United States abandoned the convertibility of the US dollar to gold, which had been a key element of the Bretton Woods System, and imposed a 10 percent surcharge on imports, setting in motion changes that eventually led to floating exchange rates in 1973.
An undervalued yen
By 1971 the yen had become undervalued. Japanese exports were costing too little in international markets, and imports from abroad were costing the Japanese too much. This undervaluation was reflected in the current account balance, which had risen from the deficits of the early 1960s to a then-large surplus of U.S. $5.8 billion in 1971. The belief that the yen, and several other major currencies, were undervalued motivated the United States' actions in 1971.
The yen and major currencies float
Following the United States' measures to devalue the US dollar in the summer of 1971, the Japanese government agreed to a new, fixed exchange rate as part of the Smithsonian Agreement, signed at the end of the year. This agreement set the exchange rate at ¥308 per US$1. However, the new fixed rates of the Smithsonian Agreement were difficult to maintain in the face of supply and demand pressures in the Forex market. In early 1973, the rates were abandoned, and the major nations of the world allowed their currencies to float.
Japanese government intervention in the currency market
In the 1970s, Japanese government and business people were very concerned that a rise in the value of the yen would hurt export growth by making Japanese products less competitive and would damage the industrial base. Therefore the government continued to intervene heavily in Forex marketing (buying or selling dollars), even after the 1973 decision to allow the yen to float.
Despite intervention, market pressures caused the yen to continue climbing in value, peaking temporarily at an average of ¥271 per US$1 in 1973 before the impact of the 1973 oil crisis was felt. The increased costs of imported oil caused the yen to depreciate to a range of ¥290 to ¥300 between 1974 and 1976. The re-emergence of trade surpluses drove the yen back up to ¥211 in 1978. This currency strengthening was again reversed by the second oil shock in 1979, with the yen dropping to ¥227 by 1980. The effect of the Plaza Accord.
In 1985 a dramatic change began. Finance officials from major nations signed an agreement (the Plaza Accord) affirming that the dollar was overvalued (and, therefore, the yen undervalued). This agreement, and shifting supply and demand pressures in the markets, led to a rapid rise in the value of the yen. From its average of ¥239 per US$1 in 1985, the yen rose to a peak of ¥128 in 1988, virtually doubling its value relative to the dollar. After declining somewhat in 1989 and 1990, it reached a new high of ¥123 to US$1 in December 1992. In April 1995, the yen hit a peak of under 80 yen per dollar, temporarily making Japan's economy nearly the size of the US.
The yen's increased value made Japanese exports less price competitive and imports more price competitive, which should have brought down the value of trade and current account surpluses. The current account figures discussed earlier, however, indicated that such a response was slow. The strong appreciation of the yen began in 1985, but the current account continued to rise until 1987. Its decline in 1988 was rather small, although it experienced a more substantial decline in 1989.