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Debate over weak yen, currency war misses point: demand is slack

by Jochen Legewie

Special To The Japan Times

Since mid-November, the yen has weakened substantially against the dollar, the euro and other currencies.

The rapid decline was fueled by aggressive policy announcements by Shinzo Abe, before and after he became the prime minister in December, calling for more fiscal stimulus and for bold monetary easing, including a new 2 percent inflation target.

Other than an initial ¥10.3 trillion stimulus package, concrete actions have been missing so far. The yen’s decline is rather reflecting the expectations of capital market players in Japan and more so abroad. Dubbed “Abenomics,” the new economic policies have been outlined by the government in a very consistent and convincing way and thus moved the markets.

But the bold statements and actual changes in exchange rates have also raised criticism from abroad, including from German Finance Minister Wolfgang Schaeuble and the influential head of the German Bundesbank, Jens Weidmann.

Foreign critics accuse — directly or indirectly — Japan of currency intervention and paint the picture of an evolving global currency war that might bring down the global economy. But this debate misses the point — there will be neither a currency war, nor will a weak yen be a solid basis for an economic revival of Japan.

Back in the 1930s, currency wars contributed greatly to the severity of the Great Depression. The departure of sterling from the gold standard in 1931 involved a devaluation of the U.K. currency against those of all of its trading partners, which responded by direct controls over free trade, including tariffs, quotas and exchange controls. This reduced world trade sharply and deepened the depression.

But nowadays tit-for-tat currency devaluations along with monetary easing are much less damaging than the direct trade and exchange control retaliations of the 1930s. The existence of bilateral and international free-trade agreements helps as does the existence of organizations like the World Trade Organization and the International Monetary Fund. Global companies depend on global supply chains as they need access to export markets. Thus we are not and will not be seeing a repeat of the “beggar thy neighbor” policies of the 1930s.

Secondly, we have to look at the facts. The yen has not even yet returned to the level of 100 per dollar, where it stood prior to the Lehman crisis in 2008 (between 2000 and 2008 the yen had even hovered between 100 and 130 per dollar). If anything, the yen was overvalued until recently and probably even is today.

Thirdly, the U.S. administration supports the Japanese government’s efforts to overcome deflation and restore economic growth. This was demonstrated by the comments of Lael Brainard, the top U.S. Treasury official in charge of international affairs, as well as those of IMF Research Director Olivier Banchard, who clearly helped Japan by stating that “increasing talk of currency wars is very much overblown.”

The U.S. has good reason to ally with Japan, because of Japan’s growing importance for the U.S. in terms of security against the rise of China in East Asia as well as the insecure situation in North Korea after the country’s recent third nuclear test.

The Feb. 15-16 Group of 20 meeting in Moscow confirmed that Japan’s economic policy and a weaker yen are internationally accepted, at least for the time being. The final statement did not mention any individual currency or country, though currency issues were obviously heavily discussed among the G-20 officials.

But even if Tokyo continues to avoid international friction over its currency, a weak yen will by far not be sufficient to restore the Japanese economy. Abenomics can only work and succeed if all of its three elements are fulfilled: renewed fiscal stimulus, higher inflation and still-unspecified structural reforms.

A weaker yen will help the economy by promoting net exports. Raising inflationary expectations should also lower real interest rates in the short run, which is good.

Upping the fiscal deficit will also boost demand in the short run, which is helpful after three quarters of economic contraction. Of course, old-style pork-barrel spending won’t do the trick. Deregulation and market-oriented structural reforms are indispensable.

But all of this still does not address the core of Japan’s economic woes: structurally weak private-sector demand.

There are several ways to do this. They all boil down to lowering companies’ retained earnings without reducing necessary corporate investment. To put it in the words of British journalist Martin Wolf, “corporate financial surpluses that end up in vast fiscal liabilities must be trimmed.”

Option one is raising wages. The government is right in strongly encouraging the corporate sector to pay higher bonuses and raise salaries as it currently does. Just consider that the average annual salary declined from ¥5.2 million in 1997 to ¥4.51 million in 2011. The outcome of the current labor-management negotiations is hence of high interest and importance.

Options two and three are similar: Change corporate governance and corporate taxation to force higher profit distributions to shareholders. Just lowering the extremely high provisions for depreciation would substantially reduce gross corporate savings, which instead become available for spending.

However, implementing such policies will face additional difficulties by the upcoming increase in the consumption tax. The government will be challenged to come up with innovative approaches to ensure continued consumption.

At present, the new government and Abenomics are on a honeymoon with the people as shown by the government’s increasing popularity in media polls. This support can, however, quickly turn into outright opposition if the people suddenly feel they are on the losing end of Abenomics.

A weaker yen is a first small step for the government. But the upcoming challenges are immense. And history and experience tell us we must not be overoptimistic with the Liberal Democratic Party.

Jochen Legewie is president of German communications consultancy CNC Japan K.K. (See his blog: www.cncblogs.jp).