The Japanese yen is still considerably below its modern highs.

(Down is “up” in this graph, ne? A lower number means you need fewer yen to buy the dollar–so, yen strengthening.)

You may be catching the headlines recently, that the yen is reaching (modern) “historic” highs around 76 yen to the dollar. In some ways, this is true, but in others, it isn’t. [Update (8/19/11): “Modern” refers to the fact that Japan had massive inflation in the years after World War II. Before then, the yen traded at some closer fraction to the dollar, like 3 to 1. I am talking about the period from 1971 onward, so-called post-Bretton Woods.]

Since the last time the Japanese yen was similarly as strong, the price level in America has gone up about 40%, while the price level in Japan has been almost flat. So you have to compare what you could buy in dollars in 1995 with what the yen traded at in those days.

To make it easy, say a hotel room was $128 and the 1995 dollar could be had for 78 yen. So you got a hotel room for about 10,000 yen (9,984 yen).

Inflation now has made that hotel room cost $179. Even at 78 yen to the dollar, you need 13,962 yen. For the yen to be as strong as 1995, the yen must be around 55 in this example.

We are no where near 55 yen on the exchange yet.

Prices have tripled in Japan since 1971, but maybe 6-timesed in America. The historical 360 yen is more like 180 if you are talking about today’s yen.

If America kept a 2% inflation, and Japan had none throughout the 21st century, it’s not farfetched that there would be a 10 yen to the dollar exchange rate in the early 22nd century. How likely is it? Probably a wild shot. But who is to say that there won’t be a 30 yen or 40 yen exchange rate sometime within our own days?

[Update: Coincidentally, I am posting this on the 40th anniversary of the Nixon speech, announcing the close of America’s Federal Reserve gold window.

Economic historians consider August 15, 1971 to be the date that Nixon devalued the dollar. But, in fact, the dollar had been devalued well before that–due to unpaid-for spending in the Vietnam War.

The gold bugs like to point out that gold has risen from the official $35 an ounce price in 1971 to about $1,800 today (a nearly 10% annual increase). But they gloss over the fact that most of that run-up has happened just in the past year or two. Because they can’t see beyond their flukey market, they don’t realize it’s another price bubble, like 1980 (gold from $250 to $800 an ounce in a short time).

The problems of our economy today (threat of depressionary deflation) are nothing like the ones of 1971 (government interference in the markets to try and cap growing inflation.)

We need the policy responses to fit the problems of the moment.]