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Why Japan Hasn't Stopped the Yen's Rise


When the yen surged to historic highs against the dollar, euro, and other currencies in December, retail investors formed lines at banks and brokerages, recognizing that there were currency bargains in the offing. After all, during 2008 the buying power of the yen surged 19% against the dollar. Against the euro and the pound the Japanese currency gained even more, rising 22% and 40%, respectively. Today, with the yen still hovering around 13-year highs against the dollar and Japan's economy sinking deeper into recession, how soon will it be until the Japanese government, albeit for different reasons, also starts selling yen?

For sure, the strength of the currency, and the damage it is causing to Japan's export-reliant economy, is raising concern in Tokyo. After weakening slightly in the first few days of 2009, it is again close to the worrying highs of a month ago; at 89 to the dollar at the close of Tokyo trading on Jan. 14. A day earlier, amid rumors that Sony (SNE) and Toshiba (6502.T) may incur operating losses during the current fiscal year, Fujio Mitarai, chairman of Nippon Keidanren, Japan's most powerful business lobby, for the first time said Japan's Ministry of Finance may have to step in. "If this situation continues for a long time, I want [the government] to intervene," Mitarai, who is also chairman of Canon (CAJ), told reporters in Tokyo. "The current rise in the yen across the board is not good for the Japanese economy."

Weaker Against Korean Rivals

The strong yen is adding to Japan's economic woes at a time when global demand for its cars, electronics goods, and other products is slumping. At Toyota (TM), which is projecting its first operating loss since 1938, a one-yen strengthening of the currency against the dollar costs $450 million in lost operating earnings. At Honda (HMC), a similar one-yen appreciation costs the company about $200 million. On Nov. 6, Honda CEO Takeo Fukui said the Japanese government should intervene to weaken the yen. "Foreign exchange has to stabilize," Fukui told reporters at the launch of new a minicar for the Japanese market.

While the impact is less spectacular at electronics makers, the strong yen is cited as a reason Sony and Toshiba may miss profit forecasts. There are also concerns that electronics companies' longer-term competitiveness with Korean rivals is being undermined. In the last year, the Korean won sank 40% against the yen, handing a cost advantage to Korean companies such as Samsung Electronics and LG Electronics.

What's more, it's not just the dollar. Today, the yen is stronger against the euro, pound, and other currencies. According to the Bank of Japan, the yen reached a nominal trade-weighted record in December. The yen's real trade exchange rate, which considers changes in price levels across countries, is at its highest level since November 2001. "It's already high time the Japanese government intervened," says Kyohei Morita, chief economist at Barclays Capital (BCS) in Tokyo. With weak domestic demand) failing to pick up the slack, Morita reckons that Japan's economy will contract 4.6% in 2009.

Companies May Benefit from Upturn

So far, though, Japanese authorities have chosen stimulus packages and interest rate cuts as means of boosting the economy rather than currency interventions. Indeed, the last time the Ministry of Finance played the foreign exchange markets (ending in March 2004) it bought $390 billion of foreign currencies over a 15-month period—weakening the yen—to prop up the economy. Back then, the yen traded at around 104 to the dollar—far weaker than today's rate of 89 or the recent 13-year high of 87.

What explains the government reluctance to take action? One reason is the relative good health of Japan's economy. Despite being in the clutches of a sharp recession, optimists believe cash-rich, debt-light Japanese companies are in better shape to manage the downturn than five years ago. One sign is that, for all their woes, many Japanese companies are taking advantage of a strong currency and low valuations to go on buying sprees of their own. And, while the downturn is painful, it's hoped that Japanese companies will be well positioned to benefit from the upturn. No Japanese automaker, for example, is yet asking for a bailout.

Japan's financial system, meanwhile, underpinned by banks, largely steered clear of subprime, credit derivatives, and other toxic investments, and is in far better shape than others. Indeed, one reason for the yen's rise is Japan's status as a financial safe haven.

U.S. Backing a Tough Sell

Perhaps a more important question is whether any intervention would actually work. Even at the best of times, it's difficult for governments to turn the tide against market sentiment. Economists say one problem is that it's hard to reverse the direction of a currency. In other words, in the yen's case, it's better to intervene when there are signs its surge is nearing an end and then use intervention to speed up the pace of depreciation. Another problem is that any intervention now may be made more difficult without the cooperation of other nations. Today, with most major economies either in recession or close to it, persuading other governments to help Japan weaken its currency, effectively making its exporters more competitive than rivals, is likely to be difficult, warns Seiji Shiraishi, chief economist at HSBC (HBC) in Tokyo. "It's a very different situation from 2004 when Japan was facing the risk of a deflationary spiral and the U.S. and Europe were in relatively good shape," he says. "Now, every country has its own problems."

Winning U.S. backing for an intervention may be tough. Lawmakers are already concerned that stimulus packages may benefit exporters to the U.S. A choreographed depreciation of the yen is unlikely to find much support in Washington. And critics contend that a low-yen policy, facilitated by ultra-low interest rates in Japan, gave Japanese exporters an unfair advantage for too long. "By maintaining near-zero interest rates over the last several years, the Bank of Japan has encouraged the carry trade, which has acted as a surrogate for direct intervention," says Peter Morici, a professor at the Robert H. Smith School of Business at the University of Maryland. "Japan and China must find a way to generate growth through Asian or home demand."

Still, for all that, many think Japan may soon act if the yen continues to surge. Eisuke Sakakibara, a professor at Waseda University in Tokyo and a former top official in the Ministry of Finance, says that if the yen keeps rising, the government will more than likely step in. "The question is even if they intervene will it be effective—intervention against the wind doesn't usually work", he says. However, "if the exchange rate approaches 85 [to the dollar] I think they will intervene. [The government] will try to stop the exchange rate going below 80." Barclays' Morita adds that even disapproval by the U.S. Administration would be unlikely to dissuade intervention. "I don't think it's a question of whether they intervene but when," he says.

Rowley is a correspondent in BusinessWeek's Tokyo bureau.

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