Commentary: Weakening the Yen Won't Make Japan Strong

It becomes clearer by the day that Japanese policymakers will try anything short of real reform to get their country out of its 10-year slump. The latest stratagem: Trash the yen, which markets had already pushed as low as 128 to the dollar on Dec. 18, and use cheap exports to stoke the economy. This shopworn rescue tactic has, in the past, earned Japan no end of opprobrium from its trading partners, who resent competing with cheap Japanese goods while Tokyo does nothing to boost domestic demand. But risking an international firestorm is not the worst part of a weak-yen strategy. The worst thing about the plan is that it won't work.

The latest variation of this currency game was a scheme to get the Bank of Japan to weaken the currency by printing yen and using the new money to buy U.S. Treasuries. As expected, BOJ Governor Masaru Hayami, historically a strong-yen advocate, nixed the idea after a policy-board meeting Dec. 18 and 19. In any case, the pressure to weaken the yen will continue, as politicians, hard-pressed exporters, Finance Ministry officials, and even some BOJ insiders continue to push the issue.

The revival of the weak-yen debate--the currency is now at its lowest point since 1998--shows how desperate Prime Minister Junichiro Koizumi has become. Though he hasn't said he favors a weaker currency, his options are narrowing. Bureaucrats and Liberal Democratic Party hacks have smothered his brave plans for recreating Japan's economy by instituting fiscal austerity, closing state-run corporations, and cleaning up the banks' debt overload. Other traditional ploys to kick-start the economy are losing power. After a series of credit-rating downgrades, the government can't issue debt to bankroll more pork-barrel projects. Interest rates are already near zero. That leaves the yen and the fantasy of an export-led recovery.

Truth is, a cheap yen won't help much. That's because exports represent only about 10% of the Japanese economy. More important, devaluation is a strategy for a Japan that no longer exists. Ten years ago, its manufacturers made most of their goods at home. Today, yen costs are a much smaller part of production because such giants as NEC, Honda, and Toyota--like multinationals everywhere--buy raw materials and parts and manufacture around the world. According to Tetsufumi Yamakawa, chief economist at Goldman, Sachs & Co., 15% of Japanese manufactured goods were produced offshore in 2000, vs. 6.4% in 1990. In fact, a cheaper yen could hurt domestic producers by driving up the cost of imported parts and oil.

The other hope of the weak-yen lobby is that by raising the cost of imports, policymakers will stop Japan's deflationary spiral. Again, the logic is flawed. A yen devaluation might raise import prices, but not enough to stop the 1%-a-year fall in consumer prices. HSBC Securities Inc. economist Peter Morgan figures a 10% depreciation in the yen adds just 0.1% to the consumer price index. "The yen would have to fall to well below 200 [to the dollar] to raise the CPI by one percentage point," he says.

Worse, in exchange for minimal gains, Japan risks exporting chaos across Asia. If the yen gets much closer to 147 to the dollar, its low point during the 1998 emerging-markets crisis, both China and South Korea have made it clear they will be very unhappy. South Korean Deputy Prime Minister Jin Nyum has warned that a Japanese devaluation strategy risks "sparking a race of depreciation in the region." Chinese Finance Minister Xiang Huaicheng recently said China wouldn't devalue the yuan to boost exports. But Beijing does consider the 130 yen to the dollar level as an important psychological threshold, beyond which the risk of currency turmoil increases.

How low can the yen go? The world may well find out in the coming weeks. Currency traders already smell a sell-off. Bernard Tsui, a trader with Union Bank of California, says he is booking a lot of forward currency contracts in the 130-yen range now, and "I expect 135 or so in the first quarter." The Bush Administration isn't helping matters. It's preoccupied by the war against terrorism and torn by internal conflicts over its Japan policy. White House economic adviser Larry Lindsey, who supported the Treasuries purchase scheme, has indicated that he doesn't object to a weaker yen. Treasury Secretary Paul H. O'Neill says currency fixes can't substitute for the tough steps Japan has to take to clean up its economic mess.

O'Neill is right. Obviously, a superstrong yen isn't in Japan's interest, but orchestrating a plunge in value is daft. A policy of damaging the economies of South Korea, Taiwan, and Singapore is bound to backfire on Japan, which exports 35% of its goods to the region. Japan and the rest of Asia need a stable yen, not a debased one.

By Brian Bremner

With Rich Miller in Washington and Moon Ihlwan in Seoul

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