The competitive depreciation of the yen

This week the yen has continued its slide against the dollar. In this article Fred Bergsten, director of the Institute for International Economics in Washington, DC, says this is deliberate Japanese policy. On the next page we give our view

JAPAN is up to its bad old tricks. The Ministry of Finance is seeking a further competitive depreciation of the yen of 10-20%, on top of its 40% decline against the dollar (and about 25% overall) over the past 18 months. The result would be a huge surge in Japan's trade surplus in 1997 and especially 1998. This would take jobs away from other countries, including European ones, where unemployment is already very high, and Asian countries that compete intensively with Japan. It would also rekindle protectionist pressures around the world and set the stage for another round of financial instability when the inevitable currency reversals take place.
     Japan's motives are easy to discern. Its economy may be dropping into renewed recession despite five years of virtual stagnation. It has barely begun to restore the stability of its financial sector. But it seems incapable of attacking its problems via the proper policy tools. Short-term interest rates hover near zero, so admittedly cannot be reduced much further by easier monetary policy. But plans are in place to reduce the fiscal deficit, even though doing so will intensify the economy's weakness. Structural reform is the real answer to Japan's problems, but is slow or non-existent.
     The finance ministry, which is particularly zealous in seeking fiscal contraction and avoiding serious structural reform, has thus reverted to its traditional remedy: currency depreciation. It justifies the strategy internationally by arguing that a weaker yen will not even reverse the recent decline in Tokyo's trade surplus from the gargantuan levels of 1992-94 because of the outsourcing of Japanese production that was promoted by the subsequent sharp rise of the currency. But why then does the ministry pursue depreciation so avidly, persistently jawboning its currency down and promoting outflows of Japanese capital, and buying huge quantities of dollars in the markets whenever the yen strengthens even a bit?
     Virtually all models show that every 1% fall in the value of the yen has traditionally increased Japan's global current-account surplus by about $3 billion. The decline in the Japanese surplus in 1995-96 will probably reach about $60 billion, following naturally from the 20% appreciation of the yen (from 125 to 100 to the dollar) in 1993-94. This occurred despite Japan's negligible economic growth. The results demonstrate once again that Japan's trade responds to currency changes in textbook fashion.
     The rise of the yen beyond 80 to the dollar in early 1995, which was clearly excessive, was too brief to have much effect on trade. But the currency probably settled around ¥90 long enough to affect pricing and investment decisions by Japanese firms and help cut the surplus to tolerable levels. A new yen decline to ¥120-130, as the Japanese authorities openly advocate, would thus represent a competitive depreciation of one-third to about one-half. Even allowing for some irreversible effects of Japan's recent foreign investments, the renewed expansion of the surplus would be enormous. It would restore the crisis levels of 1992-93 even if the relevant base were "only" ¥100, and the currency decline would thus add up to "only" 20-30%.
     Japan itself would be the major loser from this scenario. It might gain a little growth in the short run. But pressures for constructive structural reform and thus fundamental improvement of the economy would recede still further. As the trade surplus ballooned, Japan would again ignite the wrath of its major trading partners, in East Asia and Europe as well as the United States. A sharp yen appreciation would inevitably ensue at some fairly early point, cutting growth and deepening the country's economic troubles as in 1993 and again in 1995 (see chart). The Ministry of Finance would once again have undermined the very economy it is supposed to manage. The Keidanren, Japan's main business federation, has recognised all this and publicly called for holding the yen-dollar rate between ¥100 and ¥110.
     It is a mystery why other Group of Seven countries have accepted this renewed Japanese effort to export its domestic problems instead of dealing with them properly. The United States continues to run a record trade deficit, which will probably reach $200 billion for 1996, so should hardly welcome renewed yen undervaluation. Some Europeans complain that their currencies are already overvalued, with serious consequences for their slow growth and high unemployment, a charge that could hardly hold against the dollar in light of America's large deficit but could well apply to Japan. Countries outside the G7 have also been strangely quiet--although, for example, Korea's record deficits are driven importantly by the yen's depreciation against the won.
     The G7 let the yen weaken similarly in the late 1980s, bringing on the huge surpluses that triggered a global onslaught against Japan's trade policies in the early 1990s and then the sharp yen appreciation that deepened Japan's own economic malaise. We are now in fact experiencing the fifth cycle of yen swings since the early 1970s, all of which have produced serious problems for both Japan and the world economy. It is tragic that both Japan and the other major countries seem unable to learn from this dismal history. The episode is a further reminder of the dramatic decline in the effectiveness of the G7.
     With the yen hovering around 115 to the dollar, action is urgently needed to halt the depreciation and reverse it at least modestly. Lloyd Bentsen, the then Treasury secretary, let it be known in early 1994 that the United States would not tolerate a yen weaker than about 112 to the dollar, stating clearly that "Allowing the yen to slide is not an acceptable way out of recession for Japan." The Japanese now assert that this "Bentsen ceiling" has been lifted and recent market movements suggest they may be correct.
     No one wants to see the yen strengthen again to 80 to the dollar. It is time, however, for the United States and the rest of the G7 to reassert the Bentsen principle and to let Japan know that competitive depreciation is unacceptable and will be firmly resisted. Much more constructive steps, particularly regarding structural and financial reform, are available and indeed necessary for Japan to restart its economy. The intellectual bankruptcy of the Ministry of Finance must not be permitted to push that country's new government to pursue the bad old ways once again and to plunge the world into a renewed cycle of trade protection and currency instability.

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