Akio Mikuni, president of Japan's leading bond-rating agency, and R. Taggart Murphy, a professor at Tsukuba University, relate how Japan, the world's second largest economy, became trapped in deflation.
Japan is the world's top creditor nation with huge holdings of bonds, equity, loans and foreign investments. It has vast trade and current account surpluses with most countries in the world. The floating exchange rate is supposed to adjust automatically to prevent such payment imbalances, but these are now far greater than they ever were under the fixed rate system.
In the 1980s, Japan's landowners and speculators used huge real estate and equity market bubbles to take wealth from the working class. In the early 1990s, the bubbles burst, and the largest pile of non-performing loans ever seen buried much of Japan's banking system. Every monetary and fiscal policy failed, including a 72-trillion-yen reflation and bank bail-out package in 1998.
During the US state's postwar occupation of Japan, it had seized control of Japan's currency. As the authors point out, "No matter how much capacity you have accumulated, no matter how many claims you have the theoretical right to exercise, unless you control the currency of your international trade, investments, and finance, you are at the mercy of those who do control that currency."
So Japan accepts payments for its exports, and returns from its investments abroad, in the dollar. It keeps its ever-growing hoard of dollars in the USA, which transfers buying power to the USA, funding, for example, Silicon Valley. The US state's control of the yen is the key to the dollar's strength, allowing the USA to depend on imports and to run huge trade and current account deficits. It also fuelled the US bubbles in credit, bonds and equity markets.
Japan has paid a huge price for this special relationship with the USA, because the dollar has lost two-thirds of its value against the yen since 1972. Now the falling dollar is hurting Japan even more.