Published on June 29, 2020
Job titles and other details are as of the time of publication.
(The interview was conducted in Japanese and was thereafter translated into English.)

Currency substitution prompted by low confidence in a country’s own currency

I specialize in international finance and conduct research using macroeconomics and time series analysis. I recently carried out theoretical and empirical analyses of currency substitution as well as studies on monetary policies under currency substitution or unification and international financial market integration. I have also begun research on the relationship between crypto assets such as Bitcoin and currency substitution.

Currency substitution is the use of a foreign currency by a country’s citizens as a means of payment, and is widely seen in developing and emerging economies, such as in Latin America and Central and Eastern Europe, where confidence in the domestic currencies (legal tender) is low.

Latin American countries have experienced high inflation in the past, while Central and Eastern European nations are transitioning from socialism to capitalism. People who live and conduct business in countries with unstable macroeconomies are concerned about the depreciation of their domestic currencies and the safety of their bank deposits due to extremely low confidence in their countries’ currencies. To deal with these risks, people tend to make payments and other settlements using stable currencies such as the US dollar.

This situation may not be familiar to people living in Japan and settling payments in yen. The Japanese yen, also known as a safe-haven asset, is a stable currency that is traded in times of crisis. In fact, the yen was bought during the financial crisis sparked by the collapse of Lehman Brothers and at the time of Brexit. The yen’s value has also been rising during the ongoing coronavirus pandemic.

Japanese people using only the yen may seem untouched by currency substitution, but this is not the case. Bitcoin and other cryptocurrencies have created room for the yen to be replaced by crypto assets. I will discuss this topic later.

“Principles” of things strongly captivated me in my school days

I first learned about international finance through an undergraduate liberal arts course that offered only an introduction to the subject rather than an in-depth discussion.

As a student, I was strongly attracted to the principles of things. In other words, I was the type of person who felt uncomfortable with the conclusion that all things could be interpreted in various ways.

For example, multiple business strategies are analyzed by selecting possibly common elements from them to be interpreted individually using such tools as sociology and psychology. This approach can create a variety of unique studies, but I did not find it appealing. Instead, I was fascinated by universal and versatile analytical methods that explain all types of phenomena based on one basic theory. The course mentioned above made me aware of this concept.

Exchange rate movements are one of the most difficult phenomena to explain as such movements involve human behavior. In economics, economic agents, namely human beings, are thought to behave rationally. I became interested in how far I could explain seemingly unexplainable movements based on rational economic agents.

More broadly, modern economics is a discipline modeled after physics, particularly Newtonian mechanics, which is aimed at discovering the laws of nature based on the premise that nature and the world, created by an omniscient and omnipotent God, must be thoroughly rational.

Modern economics based on Newtonian mechanics also considers human beings as part of creation and attempts to discover rational laws of motion consistent with people’s social behavior. Looking back, I wanted to pursue the underlying principles of things and universal truths, so it was only natural for me to specialize in the field of modern economics.

Economics does not properly explain what money is

I became interested in currency substitution while conducting research on international finance, mainly monetary macroeconomics.

International finance is a discipline covering the two fields of financial economics and monetary economics.

The former deals with the financial field that develops into corporate finance, securities market theory, and other disciplines, while the latter examines how money affects the economy based on currencies. I focus on the latter to deepen my understanding of currencies.

Economics does not properly explain what a currency is. Why is a currency “a currency”? How does it become normal using a foreign currency instead of a domestic one? What is the rationale behind the trend? I began research on currency substitution to address these questions.

Possibility of crypto assets bringing currency substitution to Japan

Textbooks define a currency as a means of payment. But paper money is nothing more than pieces of paper. Why is this “paper” with no value in itself used as a means of payment? Why do people in Latin American and Central and Eastern European countries use the US dollar despite having currencies of their own?

Simply put, the dollar is used by everyone. Currency substitution occurs in the following way: the more people use the dollar, the more convenient it becomes as a means of payment; people think the dollar has more advantages because it is used by everyone; using the dollar becomes normal with individual decisions externally influencing other individuals; and society overall recognizes the convenience of the dollar.

This phenomenon may not be familiar to people in Japan, but when the dollar is replaced with crypto assets such as Bitcoin, currency substitution no longer becomes someone else’s business.

Crypto assets are nothing more than data, just as paper money is merely pieces of paper. However, unlike the dollar managed under US monetary policy, Bitcoin, for example, does not belong to any particular country and has no central bank. This means that its transactions are not subject to speculation from certain countries or businesses. In addition, payments can be made using smartphone apps. All transaction records are stored in a blockchain (distributed ledger technology), and the data cannot be tampered with or modified.

It is therefore not surprising to see an increasing number of Japanese switching their payment settlements from the yen to Bitcoin. This is what currency substitution is all about – using crypto assets in addition to Japan’s own currency.

Along with currency substitution, I am also analyzing Bitcoin in terms of asset bubbles. Bubbles are caused by people supposed to be rational economic agents who decide to acquire assets at higher than original prices in order to sell them off later to “greater fools” who participate in the market.

It is well known that Bitcoin caps the number of coins issued. If miners who approve Bitcoin transactions continue to receive cryptocurrency as compensation, scarcity will accelerate and trigger a bubble. With this awareness, investors can quit Bitcoin, but nobody leaves in anticipation of greater fools participating.

Days spent realizing the importance of sitting down and reading the classics

To advance this type of research I need to keep abreast of the latest papers and to steadily disseminate my own research outcomes. This is both challenging and rewarding, but I occasionally feel like sitting down and rereading the classics. Thinking back, I now realize how precious my school days were in allowing me to do so.

I strongly wish for students to spare the time to explore the classics. Any classic book would do; it does not have to be related to your field of study or be immediately useful. It is perfectly fine for students in the Faculty of Commerce and Management to delve into Shakespeare. This should be the first step toward underlying principles and universal truths.