the yen is now too weak to suit Tokyo?

In recent national elections,  the Liberal Democratic Party, led by former prime minister Shinzo Abe, seized control of the Diet, running on a platform of causing the yen to weaken against the currencies of Japan’s trading partners.  The idea was to break the quarter-century trend of domestic economic weakness by giving a temporary boost to export-oriented manufacturing and to try to end the deflation that has plagued the country since the early 1990s.

Since this idea was first suggested–the inept Democratic Party of Japan was certain to be tossed out in any election–the Japanese currency has fallen by almost 15% against the US$.  Now, in a reversal of form, the LDP wants the currency depreciation to stop.

What’s going on?

Why should it matter to the rest of the world?

The Japanese economy is like a slow-motion train wreck.  So it has a certain morbid fascination to it.  Perhaps more important, for the EU and the US,  Japan is like Dickens’ Ghost of Christmas Yet to Come.  Japan has written the manual on how not to run a developed economy with an aging population.  Hopefully, Brussels and Washington are taking note.

Three points:

1.  Except for developing economies dedicated to radical economic transformation, currency depreciations never work.  Export-oriented manufacturing may get a temporary boost.  But that quickly fades.  Inefficient companies just put off necessary restructuring.  So the economy is soon back in the same sorry shape, only with higher inflation.  In other words, economically speaking, this was a crazy idea.

2.  Politicians normally choose currency depreciation over more effective adjustment methods mostly because it’s invisible–so they can deny responsibility.  It isn’t the legislators who are inflicting pain on the economy, after all, it’s the (evil) foreign currency markets.  In this case, however, even the political rationale doesn’t hold.  Currency depreciation, over the protests of the Bank of Japan, is the centerpiece of the LDP economic program.  So the LDP gets all the blame.

3. The costs of currency depreciation, in terms of national wealth, can be immense.  In Japan’s case, the cost of goods and services produced abroad is suddenly 15% higher than it was last October.  This doesn’t just mean foreign vacations or real estate purchased by the wealthy.

It also means food, clothing, fuel, electric power–anything imported into the country.  Looked at a different way, the after-tax purchasing power of Japanese savers and wage earners has just shrunk by about a quarter, almost overnight.  What a disaster!  I think it’s citizen uproar over higher prices for everyday necessities that’s causing the LDP’s about-face.

I hope the LDP has a backup plan.



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