Nearly two decades after America rolled out its strong-dollar mantra, Japan seems to have adopted the opposite chant. Finance Minister Taro Aso reminded reporters yesterday about the yen's vital role in boosting job and wage growth: In the opaque world of currency predictions, that counts as a pretty clear sign that he expects the currency to drop even further than its current rate of 120 to the dollar, down 16 percent since mid-year.
How low might the yen go? Opposition lawmaker Takeshi Fujimaki, a former banker, may be off-base when he warns the currency could eventually hit 200 per dollar. But with growth faltering and Prime Minister Shinzo Abe doing far more talking than restructuring, Japan is depending on a weaker exchange rate to boost export earnings. A rate nearer to 150 is hardly out of the question.
There's a view in Tokyo -- and a certain tolerance in Washington for it -- that if a weaker yen helps Japan whip deflation, then the end justifies the means. But this reasoning suffers from two big flaws. First, while the yen's plunge has filled the coffers of large exporters and boosted tourism receipts, overall it's doing more harm than good by making imports much more expensive. Windfall corporate profits are lifting the onus off Japan Inc. to innovate and Abe to deregulate the economy.
The second problem involves the economic and geopolitical fallout of the yen's swoon. Just as the Federal Reserve needs to think carefully about how raising U.S. interest rates will affect developing nations, Japan must consider the damage caused by a continuing freefall. It's no coincidence that China’s yuan plunged the most in six years yesterday, spurring fears of a new currency war in Asia.
"The Bank of Japan's effort to weaken the yen is a beggar-thy-neighbor approach that is inducing policy reactions throughout Asia and around the world," Nouriel Roubini warned in a recent op-ed. "Central banks in China, South Korea, Taiwan, Singapore, and Thailand, fearful of losing competitiveness relative to Japan, are easing their own monetary policies, or will soon ease more."
Exchange-rate battles are largely a zero-sum game. For one currency to drop, another must rise -- just as when one government's trade balance brightens, another's darkens. In 1997, a round of competitive devaluations rocked the region. This time around, a regional currency war could encourage Europe to follow suit, complicating America's recovery as the dollar soars.
U.S. senators will have a hard time demanding that China stick to a stronger yuan while giving ally Japan a free pass. President Barack Obama is sure to hear complaints from key U.S. allies as well. Bank of Korea Governor Lee Ju Yeol has already warned, "We will not stand pat" as Japan devalues. If China follows suit, countries like the Philippines, Indonesia, Malaysia and Vietnam that are competing at the lower end of the manufacturing spectrum will face a rough 2015.
For such an advanced economy, Japan takes an almost developing-nation view of exchange rates. Remember that Washington's strong-dollar policy, the brainchild of then-Treasury Secretary Robert Rubin, began in 1995 just as deflation was wrapping its tentacles around Japan. Nearly 20 years on, Japan still favors the quick-and-easy fix afforded by a falling currency. Its competitiveness has only suffered.
So has its debt position. Fujimaki's 200-yen scenario sees Bank of Japan Governor Haruhiko Kuroda running out of options to “camouflage” rising default risks. Fujimaki worries the yen "will spiral out of control" as the disconnect between Japan's 250 percent debt-to-gross-domestic-product ratio and its shrinking population grows. Tokyo appears to have zero plans to address the problem, save the odd sales-tax hike.
Unsurprisingly, the government isn't talking much about that crushing debt burden ahead of Sunday's snap elections. Aso and Abe might want to cut out the winks and nods. Japan -- and the world -- deserve a real debate about where the yen is headed.
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