NEW YORK (MarketWatch) -- The Chinese yuan now has a bit more competition in the contest for the most undervalued currency. The weakness in the Japanese yen is dominating the market's attention as financial leaders from the Group of Seven leading industrial nations prepare to meet in Essen, Germany, this weekend. European officials, worried about the impact of a rising euro on the eurozone's economy, have complained that a weak yen gives Japan an unfair trading edge. What the G7 meeting is really about -- Gucci handbags But will anybody listen to their complaints? The yen slumped to a four-year low against the dollar, an all-time low against the euro, a 14-year low against the British pound, and nine-year lows against the Australian dollar, New Zealand dollar and the Swiss franc earlier this year. Japan's currency has been especially weak versus the euro in recent years, losing about 50% of its value since the end of 2000. Not only is the yen weak in nominal exchange rates, but deflationary pressures in Japan over the past years have made the currency even more competitive in real terms. The latest data from the Bank of Japan showed that in January, on a real trade-weighted basis, the yen fell to its lowest level since 1985, the year the G7 signed the Plaza Accord and caused the yen to appreciate -- a move that ultimately dragged the Japanese economy into a decade-long economic slump. Read Bank of Japan statistics. The Economist's Big Mac index showed that the yen was the most undervalued of all developed countries currencies -- meaning that burgers are cheapest in Japan. The index, built on the theory of purchasing-power parity, measures how much currencies should adjust to equalize the price of a McDonald's Big Mac in different countries. The yen was 28% undervalued against the dollar at the end of January, according to the index. Read the Big Mac index. In fact, the yen has also devalued hugely against the yuan in recent years, leading some analysts to suggest the yen is now cheaper than the yuan, which is also known as the renminbi. Stephen Jen, a currency analyst at Morgan Stanley, argues that by some measures, the yen is now 16% undervalued against the dollar, while the yuan is only 4.7% mispriced. "The yen is possibly three times more mispriced than the Chinese yuan is," Jen said. "Relative to the yuan, the yen is much more mispriced." Weighing heavily on the yen: Japan's key short-term interest rate, currently at 0.25%, is the lowest among all major economies. With the country still scarred by the memories of decade-long deflation, Japanese monetary authorities continue to err on the side of caution. The notorious "carry trade" is another big factor behind the yen's slump. The yen has been widely used as a funding currency -- in which speculators make profits by borrowing (selling) the yen at low costs and reinvesting in higher-yielding currencies and assets, such as the New Zealand dollar, the British pound, and the Icelandic krona.
"Be reminded that every time the Japanese economy has been looking at a recovery over the past 15 years it has failed because of low domestic demand. There are good reasons why the interest rate is low," said Ian Copsey, senior financial analyst at Global Forex Trading. | 
