Japan’s Conundrum: Reconciling the Hot Yen with a Not-so-Hot Economy

I’ve used Japan as an example of what crippling asset and credit crises may leave in their wake. In Japan’s case, it is almost two decades’ worth of negligible or no economic growth. And now the conundrum — while the economy is breathing its shallow breaths, Japan’s currency is skyrocketing. While at face value it may seem like a good thing, the rising yen is spelling doom for Japan’s crucial export sector.

I don’t speak “car” well, but if I were to compare Japan, the world’s third largest economy, to a car, I would have to say that Japan’s economy has been driving in reverse for so long that it may have forgotten what it means to at least shift to “P.” And, as the fragile U.S. economy most likely is headed for the double-dip recession, dragging with it other world economies, kicking and screaming, things are not looking up for Japan. Quite the contrary.

Just like policymakers in the U.S. are contemplating adopting further stimulus measures, Japan went beyond the contemplation stage and went straight for expanding its $236-billion bank credit program by a third. And, as more money was pledged towards boosting the domestic demand, the currency markets had an unpleasant jolt when the yen started rising sharply against the U.S. dollar and euro. To illustrate, since April of this year, the yen has increased 12% against the U.S. dollar.

It is quite a paradox; Japan, with its red-hot, sky’s-the-limit currency and its sickly yellow, weak economy. Let’s just say there were quite a few FX traders and currency analysts scratching their heads recently. What most are also seeing is that the yen might be miles away from hitting the resistance level. At the same time, what the yen’s ascension leaves behind is a growing aversion to any risk-taking and further deterioration of trade imbalances.

What is the yen doing to Japan’s manufacturing sector? Well, it’s just killing it. According to a number of government-sponsored surveys, about 40% of Japanese manufacturers fear that, unless the yen stops rising, they might be forced to shift their production lines abroad where labor and facilities are cheaper at least.

Is there anything that can stop the yen? Not much, other than pulling together a massive government stimulus package together with similar in size and intention stimulus packages from other central banks. At the same time, I don’t see how that’s going to happen again!

What Japan has going for it? Luckily, the country has a few saving graces. For example, before the yen started its new rise to infamy, Japan had considerable trade surpluses and one of the highest domestic savings rates in the world. That made the country one of the few remaining providers of real capital in the world, not just printed paper money. As a result, during the recession of 2008/2009, Japan’s currency, along with the Swiss franc and the greenback, was considered a safe haven, to which many investors flocked. Even the Chinese have started diversifying away from U.S. bonds and have been stocking up on Japanese bonds.

What on earth is pushing the yen so high all of a sudden? Japan is getting older and fewer babies are born into that part of the world. At the same time, Japan is exporting more, because the domestic demand is shrinking. Adding to the pile is Japan’s hoarding of foreign assets, including bonds and equities, although recently Japan started repatriating some of the capital back into Japan.