Japan Has More Than Just a Yen Crisis

It's the economy that cried wolf.

With growth slowing, deflation deepening, and the yen inexplicably surging in late August, Japanese policymakers pledged bold action. Bank of Japan Governor Masaaki Shirakawa rushed home from Jackson Hole, Wyo., to deal with the emergency. Investors braced for aggressive intervention. The media mobilized on Aug. 30 to cover Prime Minister Naoto Kan unveiling a fat stimulus package to counter the export-crimping effects of a strong yen. Then—nothing.

Disappointment over token efforts resulted in exactly what Japan didn't want: an even stronger yen, which has gone from 85.2 to the greenback on Aug. 23 to 84.4 on Sept. 1. Suzuki Motor Chairman Osamu Suzuki, who has built a big export business for his company's sturdy little cars, speaks for many when he says of the currency: "I spend every day feeling anxious about this."

So do politicians in Tokyo. That they are at a loss to do anything about it has Japan suffering the same fate as Aesop's boy who warned of crisis so often that no one took him seriously anymore.

As the dollar and euro slide, the yen rises by default. Rarely before has it been so difficult for Japan to control its currency. The yen's jump to a 15-year high says much about where Japan finds itself in 2010. Here are three specific things to consider about Japan's plight.

1) The price of Japan's aversion to change is going up. After the boom-and-bust 1980s, the government should have rid banks of bad loans, deregulated industry, made tax policies more pro-business, raised productivity, and encouraged entrepreneurship.

If Japan had done all these things, it would have a much better balanced economy today, and the yen's value would not matter nearly so much. Instead, Japan opted for Band-Aids such as massive government spending, low interest rates, and a weaker yen.

Exchange rates became a particular obsession in the 2000s as Japan focused on its export behemoths to maintain a trade surplus. To their great surprise, Japanese policymakers discovered that the currencies of nations that export more than they import go up—especially in crisis-wracked times, when investors seek safety. The bureaucrats also learned that companies, even those with strong Japanese roots, react to strong currencies. The Renault SA-Nissan Motor alliance, for example, recently announced it is increasing production in South Korea to cut its reliance on Japan as a manufacturing base.

Now, thanks to the glacial pace of change, Japan's relevance globally is waning. China's economy officially surpassed Japan's in size in August. The moral of this story? "Don't cry about the strong yen, fix the problem," says Naomi Fink, strategist at Bank of Tokyo-Mitsubishi UFJ in Tokyo.

2) Japan is being overwhelmed by international forces. At play are global trends far beyond the reach of bureaucrats in Tokyo. Yet its postwar business model worked so brilliantly that the corporate elite are reluctant to change. Ditto for a government that remains wary of immigration and empowering women to offset a rapidly aging workforce.

This delicately calibrated status quo is getting harder to maintain. Trade surplus aside, there's little economic justification for the yen's 28 percent jump against the dollar since Sept. 1, 2008.

Japan didn't fix its leaky roofs when the sun was shining prior to the 2008 collapse of Lehman Brothers Holdings. Now that the world economy is raining bad news, the nation is paying the price. So are its 126 million people and investors who bought into a revival that was more hype than reality.

3) Political paralysis is taking its toll. There's a reason currency traders aren't living in fear that the Bank of Japan will sell yen: The nation's policymaking apparatus is more uncoordinated than ever.

Part of the problem is that Japan can't seem to hang on to a leader: If a Sept. 14 election goes badly for Kan, Japan could have its sixth prime minister in three years. "Twenty years after the bubble, it would be nice to have, if not a plan, at least a sense of urgency," says Nicholas Smith, director of equity research at MF Global FXA Securities in Tokyo. "And a leader who stayed long enough for the outside world to learn his name."

This leadership vacuum feeds deflation. In July, consumer prices excluding fresh food fell for a 17th consecutive month. The best way to get consumers to save less and spend more is to convince them the future is bright. That goes for business, too.

Such optimism is in short supply. Suzuki, for one, is speaking out with greater frequency—and greater pessimism—these days. "I want Tokyo to hear our wailing," he says. Policymakers do. It's just that they have been doing their own fair share of crying—even as the world passes Japan by.

The bottom line: Japan's yen crisis is symptomatic of a major policy failure to diversify the economy and make it much less reliant on exports.

With Makiko Kitamura

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