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Yen’s Recent Surge Hurting Japan

Rajaram Panda, Ph.D. - 9/5/2011

The steady appreciation of the Japanese Yen is hurting Japan’s economy at a time when it is still struggling to recover from the March 11 earthquake and tsunami and the unresolved crisis at the Fukushima Daiichi nuclear power plant. The administration of Kan Naoto government was unable to implement policy measures to deal with the catastrophe. His successor Noda Yoshihiko, who was the finance minister in the Kan Cabinet, is expected to understand financial matters better and therefore has a tough job to do to rein in the surging Yen. When the Yen ventured near its March 17 high of 76.25 against the dollar in early August 2011, Japan suddenly faced with one of the biggest challenges that its weakened economy was facing. Both the government and the central bank intervened and made concerted push to bring down the surging Yen. But solo Yen-selling interventions will not lead to any long-term results. How much of an effect Bank of Japan’s monetary easing will have on reining in the Yen or preventing an economic slowdown remains unclear.

Exchange rates are dictated by the market. Some people suffer the brunt of a strong yen while others gain from it. Manufacturers with a high export ratio lose a lot while consumers and corporations considering to buy assets abroad gain. The reason for the Yen’s surge is the reflection of a weakened euro and dollar, more so than it is the circumstances in Japan.

The Yen’s advance was paused by Yen-selling and dollar-buying intervention. Its future course remains uncertain, however. The reasons behind the Yen’s surge are many. Its impact on the country’s economy will be of tremendous hurt. The relative performance of any two countries economies is the key to set the foreign exchange rate between the currencies of the two countries.

The staying power of the intervention by the government and the central bank may be short-lived as past moves suggest that Yen’s surge remained unchecked, thereby continued to hurt its export-driven economy. When Japan intervened in the currency market on 4 August by selling an undisclosed amount of Yen to keep it from reaching new high, traders estimated that Japan had spent just under 1 trillion Yen or $12.4 billion. In doing so, Tokyo’s move to stem the market was unilateral and it did not get the desired support from Group of Seven nations who were expected to join the expected intervention too. Japan’s then Finance Minister Yoshihiko Noda and now Prime Minister hinted further intervention, if necessary. On March 18, Japan and the G-7 industrialized countries had jointly intervened in the foreign exchange markets to push down the Yen, but this time, Japan did not get the desired support and therefore intervened alone.

The government’s currency intervention on August 4 was the third time in less than a year that the Japanese government moved to address the strong Yen. A continuing surge in the Yen makes Japan’s key export sector less competitive abroad, besides prompting enterprises to move their production abroad, thus hollowing out the economy.

Despite Japan’s massive public debt which is about twice the size of its gross domestic product, demand for Yen has remained strong. According to quarterly Finance Ministry statistics, as of the end of June 2011, Japan’s outstanding debt hit a record 943.81 trillion ($12 trillion), an increase of 2.1 per cent from three months earlier. This is the largest among industrialized economies. In principle, the government’s long term debt should be paid back with taxpayers’ money. Compounding with this, growth prospects continue to remain weak. The debt amount has been increasing by several tens of trillions of Yen annually. Economists warn that the snowballing of the debt could trigger a sell off of the Yen and Japanese government bonds and stocks within several years. The Japanese government has not been able to rebuild its finances for more than 10 years partly because it failed to increase taxes.

The Bank of Japan emphasizes on near-zero rates and a stable monetary policy. This makes the currency look like a safe haven, making it attractive to investors. Despite the sluggish demand for a long time inhibiting spending, domestic demand is expected to pick up as Japan’s reconstruction gathers steam.

Appreciation of the Yen hurts the Japanese economy because manufacturing still makes up 20 per cent of total economic output, just above Germany’s 19 per cent and well below 13 per cent in the US. Though Japanese manufacturers respond to Yen’s strength by boosting productivity both at home and overseas production units, thereby offsetting loss to some extent, it still hurts the country’s economy. For example, Sony’s competitiveness with Korean rivals such as Samsung Electronics Co. and LG Electronics Co. has remained weak as, for example, a 10 per cent rise in the Yen takes away as much as 18 per cent of profits by Japanese manufacturers.

Japan’s deflationary condition is a big factor contributing to the Yen’s surge. Though the government and the Bank of Japan are making strenuous effort to pull Japan out of deflation, it is imperative that Japan pushes reconstruction efforts vigorously to dispel deflation.

Indeed, the Yen’s strength has been driven by global rather than domestic factors. A global stock rout erased more than $6 trillion off equities in just two weeks in August, thereby bolstering Yen’s appeal as a safe haven and undoing intervention that helped the currency weaken past 80 Yen. The Yen has been trading at 76-77 per dollar after posting a post-war record of 76.25 Yen in March soon after the earthquake. According to Jean-Claude Trichet, President of the European Central bank, intervention must be made on a multilateral consensus, thereby disapproving Japan’s unilateral intervention.

The surge of the Yen is not as a result of investors putting faith in the growth of the Japanese economy; it resulted from a loss of confidence in US national bonds and the dollar as the US faced difficulties in raising its debt ceiling.

Japan’s finds itself in a difficult situation. The US Federal Reserve has decided to maintain its virtually zero-interest rate policy until mid-2013. This means dollar will continue to be sold and Yen will rise further. There is a fear that the Yen might rise further to 70 Yen a dollar if the intervention by the government of Japan and the Bank of Japan do not take action in a timely manner by infusing funds to the markets. The Federal Reserve’s statement of August 9 means that the US economy will not recover until 2013, resulting in job loss and more deteriorating condition. This will impact global economy.

The root cause of stock market declines around the world is more to do with anxiety about European economies than the rising Yen as the sole factor. While the Yen is likely to trade in the 75-79 Yen range against the dollar, the Nikkei 225 Index will range between 8,600 and just under 10,000 points. Japan has no option than to loosen its monetary policy if it is serious to stem the Yen’s rise. With falling dollar, Japan has few policy options on hand.

There is a contrarian argument that holds the view that Yen’s rise will help the economy more than it hurts. It argues that though the Yen’s exchange rate has advanced, its effective exchange rate has not climbed in a way that factor in inflation and trading volumes. The second argument is that the “benefits of having a strong yen will outweigh any damage it does to the Japanese economy, although an increase in the nominal rate pushes down the profits of export-driven companies”. Therefore, it is argued, that the benefits to Japan of Yen’s rise should be seen from macroeconomic terms. The consumers benefit the most from a stronger Yen. When there is a rise in international prices of food and crude oil, and with no rise in wage, a strong Yen can accrue benefits to the consumers as it would help pushing down import prices. This is important because consumer spending is the largest single component of gross domestic product. This view argues that distinction should be made between the micro-level damage a strong Yen does to the earnings of export-oriented businesses and the benefits that a strong currency creates in macroeconomic terms.

The reality, however, is different. The strong Yen and damage from the March 11 earthquake slashed combined pretax profits of 472 companies by 19 per cent in the first quarter of fiscal 2012. Manufacturers were hardest hit. The electronics industry suffered a 56.4 per cent plunge and transportation equipment industry (including automakers) recorded a 28.1 per cent fall. Production fell after the earthquake disrupted parts supply chains. The sluggish performances of the manufacturers affected other industries such as shipping, and land transportation industry (including railway and trucking companies). Sharp debated to relocate production facilities overseas.

The argument that a strong yen accelerates a shift to overseas production by manufacturers by establishing factories is weak as emerging economies will continue to attract production units by overseas firms regardless of foreign exchange circumstances. What the government needs to focus is on improving the productivity of domestic industry based on a realistic structural shift from a manufacturing-oriented to a service-oriented industry. For Japan, a rising Yen is both a challenge and an opportunity and it is up to the Noda government how it handles the situation.

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Sources:

http://www.asahi.com/english/TKY201108110249.html

“Strong yen bites into manufacturers’ profits”, The Asahi Shimbun, 3 August 2011, http://www.asahi.com/english/TKY201108020266.html

“Yen surge threatens to erase rebound”, The Japan Times, 3 August 2011, http://search.japantimes.co.jp/print/nb20110803n2.html

Takashi Mochizuki, Takashi Nakamichi and Megumi Fujikawa, “Japan Launches Campaign to Weaken Yen”, The Wall Street Journal, 4 August 2011, http://online.wsj.com/article/SB10001424053111903454504576487480347183232.html

“Economists: Yen to rise after Fed decision”, http://www.asahi.com/english/TKY201108110250.html

Teruhiko Mano, “Unbeautiful yen’s rise will help the economy more than hurt it”, The Japan Times, 8 August 2011, http://search.japantimes.co.jp/print/nb2011080jp.html

Ibid.

Strong yen bites into manufacturers’ profits”, The Asahi Shimbun, 3 August 2011, http://asahi.com/english/TKY201108020266.html