The yen continues to appreciate as Japan struggles to get a handle on recovering from the March 11 earthquake and tsunami, the unresolved crisis at the Fukushima No. 1 nuclear power plant, and the inability of the administration of Prime Minister Naoto Kan to implement policy actions to deal with the catastrophe.
The yen recently ventured near its March 17 high of ¥76.25 against the dollar. Although its advance has been paused by the yen-selling, dollar-buying intervention, its future course remains uncertain. What is behind the yen’s surge and what will be its impact on the economy?
First of all, a foreign-exchange rate allows the currencies of two countries to trade, so it must reflect the relative performance of their economies.
While Japan’s political-economic situation is hardly something to be envied, the reality is that the yen is being bought in a comparison that pits the Japanese economy against that of the United States — whose sovereign debt was downgraded despite a last-minute deal on raising the debt limit — and the European Union, whose most heavily indebted members remain in crisis.
So rather than winning a beauty contest, the yen is being chosen by default in a sort of least-ugly contest.
What about the economic impact?
First, we need to realize that even though the yen’s nominal exchange rate has advanced, its effective exchange rate hasn’t necessarily climbed in a way that factors in inflation and trading volumes. If there is a 3 percent gap in the inflation rate between two countries, then the currency of the country with the higher rate should naturally fall 3 percent a year. This is because higher inflation pushes up costs and negatively impacts competitiveness.
The second thing that should be noted is that the benefits of having a strong yen will outweigh any damage it does to the Japanese economy, although an increase in the nominal rate pushes down the profits of export-driven companies.
For example, it is often reported that automakers lose hundreds of millions of yen every time the exchange rate rises by ¥1. But changes are taking place in the import-export business and about 45 percent of Japan’s exports are now sold on a yen-denominated basis. Meanwhile, trade in commodities, such as LNG, which is being imported in sharply higher volumes because of surging crude oil prices and the shutdown of nuclear reactors in Japan, continues to be conducted in dollar terms. As a result, Japan now has a deficit in its dollar-denominated trade, which means a strong yen will reap more benefits for Japan in macroeconomic terms.
Most of all, it is the consumers who are benefitting from the stronger yen. Amid rising international prices for food and crude oil, Japanese consumers, who can hardly expect wages to rise much, stand to gain a lot from a strong yen that can push down import prices. And consumer spending is the largest single component of gross domestic product.
We need to distinguish between the microlevel damage a strong yen does to the earnings of export-oriented businesses and the benefits that a strong currency creates in macroeconomic terms. We need separate actions to deal with each aspect.
A recent news report said that ¥80 to the dollar was the exchange rate anticipated by most Japanese firms this year. It is up to each international company to pick a rate for its business plans, but each must also bear the consequences of being wrong on an individual basis. In a market economy, they have to take the blame for any error in judgment on the trend in currency markets.
They also have to realize that if a government is to intervene to stem turbulence in exchange rates, it must intervene in both directions to move the yen.
An effective means of avoiding the risk of currency market fluctuations is to conduct transactions in yen-denominated terms. This is why nearly half of Japan’s export deals are executed on a yen-denominated basis.
Whether a company can trade in yen terms will depend on the international competitiveness of its products. In other words, a company that cannot trade in yen terms needs to realize that its products are not competitive enough and respond accordingly.
Teruhiko Mano is an international economic analyst.