Pacific Perspective
Pacific Perspective
The Financial Times editorial that appeared on the last day of 2001 quoted a grim joke that went around the financial circles: "What is the difference between Argentina and Japan? Five years." Can a weakening
yen help Japan?Although no one wishes to witness the collapse of Japan's economy, this joke highlights the alarming status of its current economic problems. Japan has suffered from deflation since 1998, huge government budget deficits (as large as 7 percent of GDP), a credit crunch despite a zero-interest rate policy, non-performing loans in the banking sector (amounting to as much as $1.1 trillion), and a dismal stock market performance (with 28 percent drop in 2001).
Lately, we have seen a rapid devaluation of the yen. In the last quarter of 2001, the Japanese yen declined by almost 10 percent from &YEN119 to &YEN131 against the U.S. dollar.
Senior officials of Japan's Ministry of Finance are sending signals to the market that a weaker yen is acceptable. Why? Two reasons may be cited. First, they hope the devaluation of the yen helps reactivate Japan's economy through increased exports. Second, they hope a weaker yen can curb Japan's deflation, which has been eroding the profits of Japanese manufacturing firms.
Is devaluation really an effective policy tool for Japan at this stage?
A weakening yen is indeed good news for Japanese exporters because they can sell more abroad at a higher profit margin as export prices become more competitive. However, increased exports will not be able to rescue Japan's shrinking GDP because Japan's net exports (after deducting imports) contribute less than 2 percent to its GDP.
The devaluation may be effective in curbing deflation if the yen takes a deeper and larger plunge. However, Finance Ministry officials cannot allow the yen to plunge that dramatically for two reasons: First, increased import prices mean foreign goods become more expensive in Japan, which will hurt Japanese consumers. They may avoid making purchases as domestic prices rise. As a result, domestic consumption in Japan may decline further. Because domestic private consumption accounts for more than 55 percent of Japan's GDP, the growth of its economy will be adversely affected. Second, if the yen weakens more, foreigners may withdraw their investments from the Japanese stock market to avoid substantial exchange losses. What a disaster for fragile Japanese banks that would be.
Recognizing these possibilities, currency market traders predict only a mild devaluation for the yen, around &YEN135-&YEN140 to $1 in the near future. Unfortunately, this magnitude of devaluation is not large enough to stop deflation.
If the devaluation of the yen is not the ultimate solution to Japan's economic problems, then what are the alternative policies for Japan?
Policy makers must go back to the fundamental, structural problems. They must attend to the banking sector's problems and privatize public-sector corporations, including the postal savings system.
Certainly, the reform programs of Prime Minister Junichiro Koizumi are not aggressive enough. They are just too slow, too compromising and too insignificant.
S. Ghon Rhee is the K. J. Luke Distinguished Professor of International Finance and Banking at the University of Hawaii at Manoa College of Business Administration. Reach him at rheesg@hawaii.edu.