High Stakes

Jesper Koll is a Managing Director and Head of Research at JP Morgan Japan Securities Inc. He has been analyzing and investing in Japan since becoming a resident in 1986.

The weak dollar is killing Japan. On top of turbo-charging domestic deflation, it is exposing the lack of a concrete macro-economic policy strategy from the government.

Prediction: the stronger the yen gets, the greater the risk of the Democrats losing this summer’s upper house election.

Make no mistake – a strong yen is bad for Japan’s economy. Theoretical talk about yen appreciation being good for the country is naive at best, and dangerous in reality. Why? Because in reality Japan is not a textbook-style equilibrium economy but one that stands on the brink of a deflationary spiral. The facts suggest as much: All markets of the economy – land, labor, capital, and goods & services – are registering a steady acceleration in the depreciation of prices. Consumer prices are falling by 2.5 percent, producer prices are dropping by 3 percent, the GDP deflator is down 2.6 percent, land prices are dropping by 10 percent, wages are falling by 3 percent and unemployment is rising. To top this off, Japan’s stock market  is now the only stock market that is down (the Topix index was down 3.5 percent year-to-date, at the time of this writing, while global markets were up around 20 percent in America and Europe, and more than 30 percent in the emerging world). Indeed, by the end of 2009, Japan was truly “special” amongst global countries precisely because it was the only major country ensnared in all-around deflation.

Yet what do policy leaders have to say about this? Very little, except some high-minded talk about how a strong yen could be good for Japan because it should help re-allocate resources away from exporters to domestic services. Really? True, in the old Japan, a strengthening currency has always encouraged manufacturers to invest in more productive machinery and focus on raising productivity thus keeping their competitive edge. However, this only works when companies make money, when cash flow is high or when banks are willing lenders. In other words, when the economy is growing and both prices and profits are rising, a strengthening currency is an elegant tool to keep corporate leaders from getting fat and lazy. Nevertheless, today’s Japan is not growing, prices are falling and profits are plunging. A strong yen in this environment is akin to a man being kicked while he is down.

Illustrations by Phil Couzens

Moreover, the idea – as claimed by many policy makers – that a strong yen will help stimulate domestic demand and the domestic service is, frankly, nothing but voodoo economics a la Japonaise. Why? Theoretically, a strong currency frees up resources (labor) from the tradable goods sector (the export industries). These resources can then be re-deployed by the domestic non-tradable goods sectors – the domestic service sector. But this is theoretical economics, where the starting point is full-equilibrium. But Japan is not in equilibrium, its unemployment rate is at a record high and the last thing the economy needs is the “freeing up” of resources from one industry. Japan needs more, not less, employment in the export industries if it wants to regain growth and prosperity.