Weak Dollar Leaves Yen Nowhere to Go but Up

It's hard to keep a straight face as economists in Tokyo gush over a bit of growth. Japan's economy expanded at an annualized 4.8% rate from July to September. Never mind that growth is still down 4.5% year-over-year. Or that exports plunged 23.2% in October. Or that Tokyo is awash in high-rise construction projects it doesn't need. Recovery is said to be afoot. Not quite—and three inconvenient facts buttress this skepticism. First, the strong yen. Second, deflation's return. Third, the new government's solution to both challenges is as futile as the last one's. No wonder some analysts see the Nikkei 225 Stock Average soon sliding to 8,000. Why shouldn't stocks fall when politicians blame the Bank of Japan for deflation and the central bank points the finger right back at them? The yen's surge greatly complicates things. It means the government and the BOJ need to work together to stop prices from falling. That they're not is bad news for investors. The BOJ does have a point. For 15 years, politicians have called on the central bank to do more. Zero interest rates? Not enough, politicians screamed. Quantitative easing? Not impressed. Channeling funds to businesses as global growth plunges? Yawn. All government officials have done is pour untold trillions of yen into public works projects that produced an army of white elephants. Other than unneeded dams and bridges and a public debt nearly twice the size of its $4.9 trillion economy, Japan has little to show for its spending. Raising taxes can't spur consumptionIt's time for the government to meet the BOJ halfway. The key isn't just being bold, but trying something different. Yukio Hatoyama's Democratic Party of Japan, in power since September, is tweaking policies to give more financial support to households. Yet Prime Minister Hatoyama's economic team is already leaning on the BOJ to do more. Finance Minister Hirohisa Fujii called on the central bank to respond to the deflation threat. So did Financial Services Minister Shizuka Kamei. A look in the mirror would help. It's bizarre, for example, that Japanese officialdom is focused on raising consumption taxes to pay off debt. The reason for all that debt is a lack of consumer demand. In what alternative universe do they think higher taxes will reverse things? Let's try lower taxes instead. Supply-side economics is a dubious concept, but it's time Japan encouraged small businesses to create new jobs, boost productivity, and raise incomes. Why take the same measures over and over again when they aren't working? Here, Richard Jerram, chief economist at Macquarie Securities in Tokyo, suggests a money-funded tax cut. The government would send households a check, issue debt to fund it, and ask the BOJ to buy it and hold it in perpetuity. That might be too radical for some in Tokyo. Yet we need a clean break with the discredited policies of the past. Tokyo pours concrete Band Aids in rural areas at a time when Japan's competitiveness is hemorrhaging and China's is booming. There's no time to waste. Many fear renewed credit-market turmoil. A proposal last week by property developer Dubai World, with $59 billion of liabilities, to delay debt payments shook global markets. Dubai may be the latest example of the uncanny correlation between efforts to build the world's tallest building and financial crises. high yen, weak global demandThe world has another bubble in the strong yen. On Friday, Fujii said he may contact the U.S. and Europe to act as the yen trades at 14-year highs. Yet intervention would do little. With the dollar trading like an American peso, it's not clear what authorities can really do here. While the Ministry of Finance obsesses over exchange rates, it's failing to rethink a rickety economic model. Even if the yen falls, the global demand isn't there for Japan to export its way to stability. You can bet ugly deflation numbers in the months ahead will preoccupy Fujii and Kamei, just as price data have busied previous governments. Sadly, policy makers here see deflation as the fundamental problem when they ought to see it as a symptom of a bigger one. The "animal spirits" of which John Maynard Keynes spoke can be cagey. Many Japanese don't spend more because they lack confidence in the future. The rise of developing Asia complicates the extent to which human emotion and behavior confounds policy makers. Next year, China's economy may surpass Japan's to become Asia's biggest. This is a disorienting time, and it doesn't help that Japan's leaders are merely rearranging the deck chairs on a ship that's lost power. That sinking feeling among households is a key cause of deflation. So is a financial system that still hasn't fully recovered from the collapse of the 1980s bubble economy. The BOJ can print all the yen it wants. It's just going to end up in government bonds, not fueling fresh lending and job growth. The same old cycle is churning away as we speak. Breaking it requires a new playbook—a different way of looking at old and ingrained problems. In the case of deflation, there's no evidence that one is emerging. This bodes poorly for Nikkei bulls and yen bears in the months ahead.

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