Japan Struggle To Weaken Yen

Tadashi Nakamae, president of Nakamae International Economic Research and a former chief economist of Daiwa Securities, provides valuable insight on the Japanese currency problem in a commentary, published by the Financial Times, Thursday.

“The weaker dollar and renminbi is forcing the Bank of Japan to further ease monetary policy, which poses many dangers for the Japanese banking system.”

Tadashi Nakamae

Even if the yen was overvalued in 1995 there is little doubt that the yen is currently undervalued. Japan’s currency is now at a similar level to its peak in 1995, when it hit Y79 against the dollar, Mr. Nakamae points out.

Japanese competitiveness has increased as a result. Yet Japanese industries are not efficient, competitive nor profitable despite the facts mentioned above. There are two reasons for this.

First, zombie companies, kept alive by ultra-low interest rates and an undervalued yen, prevent surplus capacity from being reduced. They squeeze profit margins and lower productivity at healthy companies.

Second, emerging-market currencies have been undervalued since the Asian crisis in the late 1990’s.

The non-Japan Asian currencies which collapsed during the crisis have never returned to their pre-crisis levels even though their economies recovered and even enjoyed accelerated growth.

Japanese manufacturers have shifted their factories for mass production and mass consumption to emerging markets to take advantage of cheaper wages and better exchange rates.

This has taken jobs away from Japan.

Japan’s domestic manufacturers need to shift to more high value-added capital intensive products to restore their competitiveness. To this end Japan has to create domestic demand for these manufacturers’ goods.

For example, increasing services consumption, such as healthcare and nursing, as well as agriculture, will lead to a substantial rise in demand for robotics. Japan’s robotics producers have to shift their emphasis from cars to these service industries.

There are similarly huge potential domestic markets for high-end manufacturers.

The reason why an undervalued yen was maintained is mostly due to interest rate differentials.

Japanese interest rates have fallen sharply since 1990 reflecting the country’s deflationary trend.

On the other hand, American interest rates remained relatively high as inflation remained positive. Recently interest rate differentials between the two countries have narrowed rapidly and this has been reflected in yen appreciation.

Japan’s latest moves to stimulate its economy will have a limited impact on the yen. For this trend to stop, inflation needs to re-emerge in the US and its long-term interest rate to rise again.

However, deflationary pressures are increasing in the developed world, including the US.

The biggest force behind this is the undervaluation of emerging-market currencies, notably the renminbi. As China refuses to allow its currency to appreciate, inflation in China – and deflation in the developed world – are intensifying, and the correction of exchange rates in real terms is continuing.

The yen continues to be over-valued against the renmimbi and other emerging-market currencies.

As long as China or Korea rejects the appreciation of their currencies, a rising yen should be halted. But any time Japan tries to do this, it is seen as an intervention against the dollar.

Inevitable, since the renminbi and other Asian currencies are more-or-less pegged to the dollar, leaving the dollar as the only key currency against which Japan can intervene in order to produce these results.

The adjustment of the yen against the dollar and the euro, however, has been reasonable. That is surely why it will be almost impossible for any Japanese intervention to succeed. Such actions will only serve to delay the yen’s appreciation.

What would really help Japan is if the United States talked less and acted more on its supposedly firm stance against China’s manipulation of the renminbi.

More importantly, the Federal Reserve should stop talking about another round of quantitative easing, as this is a de facto dollar-devaluation policy.

Whether the Federal Reserve actually implements more quantitative easing is not significant, since hints, leaks and signals are enough to weaken the dollar.

There are two problems:

As the dollar weakens, the renminbi also weakens against the yen, euro and other currencies, giving China, their biggest competitor, an added advantage. Thus the Federal Reserve has created an unintended but very real de facto China export-support policy.

Second, the weaker dollar and renminbi is forcing the Bank of Japan to further ease monetary policy, which poses many dangers for the Japanese banking system.

This will push down long-term interest rates (short-term interest-rates are already at zero), narrowing the yield spread, which constitutes most of the banks’ profit margin (their main business of lending is losing money).

Even so, Japan’s aim should not be to stop yen appreciation but adapt to a stronger yen by accelerating structural reform by shifting from exports to domestic consumption.

If it succeeds, a stronger yen, may well turn out to have been a boon for the Japanese economy.

By Tadashi Nakamae

President of Nakamae International Economic Research and a former chief economist of Daiwa Securities.


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