Now the Economist is joining the curency debate. The G7 message was meant for China, but got lost in the post, and has ended up being delivered to Japan:
Why does Japan want a cheap yen? A history of mercantilism may be part of it. A cheap yen is one way to capture lucrative export markets. But Japan also hopes that selling yen and buying dollars will release it from its “liquidity trap”. Japan cannot stimulate its economy by cutting interest rates, because interest rates are already zero. It therefore has to find an alternative way to reflate the economy. Debasing the currency is one. Every time the Bank of Japan buys dollars, it creates yen to pay for them. Eventually, it is hoped, the supply of yen will outstrip demand. Depreciation is one result—lowering the value of the yen in terms of dollars; inflation is another—lowering the value of the yen in terms of Japanese goods. The last time America was caught in a liquidity trap it did exactly the same thing. President Franklin Roosevelt devalued the dollar by almost 60% in 1934 to help America recover from the Depression.
The yen could never fall quite that far. Nonetheless, the Bank of Japan’s efforts seem to have gained some traction in recent months. Output grew by 3.9% in the second quarter, outstripping even the United States. In the past two months, J.P. Morgan has raised its growth forecast for 2004 from around 1% to as high as 2.6%. Other banks are not far behind. Given this turnaround in Japan’s prospects, relative to those of the United States, it is perhaps no surprise that the yen is strengthening against the dollar.
But Japan’s recovery might be quite fragile. Much of the economy’s dramatic second-quarter growth was driven by strong capital spending, which increased by over 20%. Some of that strength is probably a statistical artifact: the volume of investment looks big because the price of capital goods has fallen so far. The investment boom is, in any case, unlikely to continue if share prices carry on down. The jittery reaction of Nikkei investors to the G7 communiqué suggests that a strong yen was not part of their scenario for a strong Japan.
America, it seems, wants a cheaper dollar; the Europeans don’t want a stronger euro. But no one wants to jeopardise Japan’s nascent recovery. Over time, stronger demand in Japan will translate into a stronger yen, not to mention a stronger world economy. But in the meantime, the Bank of Japan needs to continue its aggressive monetary easing, and the exchange rate is one important channel for this. In his past statements, Mr Snow seemed to understand Japan’s predicament: he gave it a sympathetic hearing, reserving his most trenchant comments for China. Perhaps, then, the G7 communiqué was bound for Beijing, but misdirected to Tokyo. Unfortunately, the markets seem to think the message was intended for Japan, and what the markets think matters, even when they are wrong.
The major foreign-exchange markets are deep and liquid. Central banks wade into them from time to time, but they rarely succeed in turning the tide. In fact, the scholarly consensus is that while central banks can reinforce market trends, they cannot reverse them. Until last week, the Bank of Japan succeeded in keeping the yen above its “line in the sand” of 115 to the dollar. That line is now gone. The Bank hopes the yen will trade at 110 or more to the dollar in the future. That line might soon be swept away as well.
Source: The Economist
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