Decision on yen awaits Japan poll victor

(News Today) - It is still unclear who will be left running Japan after a close contest for control of the ruling Democratic party concludes on Tuesday -- but the victor is sure to find vexing questions about the yen at the top of his economic policy in-tray.

Concern about the strength of the yen, which hit a 15-year high of Y83.35 to the dollar last week, has already played a big role in the battle between Naoto Kan, prime minister, and Ichiro Ozawa, his challenger.

Mr Ozawa has promised to take "all possible action", including intervention, to deal with any sharp rise in the yen. Mr Kan, for his part, has given assurances that he is ready to move "decisively" and begun practical preparations for a possible foray into the currency markets.

"We are doing various things so that the US and Europe won't respond negatively, if Japan takes some sort of action," said Mr Kan in a debate with his rival on Friday.

Behind this rhetoric lies increasingly vocal complaints from business that the yen's rise is destroying Japan's export competitiveness and threatening the economy's fragile recovery from its sharpest postwar recession.

Yet, whoever has the keys to Tokyo's elegant Kantei prime ministerial residence on Wednesday is likely to find taking action to solve the problem much harder than talking about it. In particular, he will have to take a view on three difficult questions: does the yen's strength really justify intervention; would intervention be diplomatically feasible; and might it actually weaken the yen?

While company leaders are vehement that the yen is too strong -- Osamu Suzuki, head of Suzuki Motor, warned recently that currency shifts were exceeding his company's ability to adjust -- some policymakers quietly describe such complaints as little more than an excuse for poor business performance.

Arguments that the yen is too high rest in large part on the nominal exchange rate, an indicator that ignores the fact that the US has experienced inflation over the past few decades, while Japan has spent much of that time mired in deflation.

The real effective exchange rate, adjusted for price changes and comparing the yen against a basket of currencies used by Japan's largest trading partners, tells a very different story. By this measure, the yen is considerably cheaper now than it was for most of the 1990s.

Other advanced economies are unlikely to be enthusiastic about efforts to weaken the yen, especially given that fears for US growth are a main factor in recent dollar weakness. Moreover, Japan still managed an Y800bn trade surplus in July.

Kathryn Dominguez, an expert on currency intervention at the University of Michigan, says the authorities would normally intervene when a currency was moving rapidly in a direction counter to existing economic circumstances.

"Probably for Japan right now, you would expect the yen to appreciate," says Prof Dominguez.

While Japanese officials involved in economic policy seem confident that their foreign counterparts would tolerate intervention, there is little hope that the US or European Union might be persuaded to help out.

But many analysts doubt the effectiveness of any unilateral intervention by Japan. An example of the difficulty is found in Switzerland, where the Swiss National Bank has this year intervened to curb a rise in the franc -- selling an amount roughly equivalent to 15 per cent of its gross domestic product in May alone, according to JPMorgan -- only to see its currency continue to strengthen.

The size of the challenge is exacerbated by the growth in currency markets. Average daily turn­over for yen-dollar trading was $292bn in April 1998, according to the Bank for International Settlements. This year it was $568bn.

Junya Tanase, currency strategist at JPMorgan, says that intervention remains unlikely -- and if political pressures were to force this step, success would be difficult. "I'm very doubtful of intervention's efficacy, because major currency markets are very large," says Mr Tanase. "No one can control the market trend."

Other analysts say that intervention might at least slow the yen's rise, but fear of failure will surely loom large for whomever the Democrats chose as their leader on Tuesday.

Whoever wins the contest will seek to rebuild the ruling party's battered credibility and establish personal prime ministerial authority. Being steamrollered by the currency markets would be a bad way to start.

Source : CNN

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