Burn Econ Textbooks? Fly Away with Sooper Yen

It goes without saying that one part of the job description for an economic civil servant--spoken or unspoken--is to talk up the local economy. So here we have an interesting paradox for Takehiko Nakao, vice minister for international affairs at the Ministry of Finance. (Remember too that this post was once held by Eisuke Sakikabara, "Mr. Yen".) Instead of talking up how Japan is emerging from its lost decade or more contemporaneously from the recent earthquake, his brief is talking down the yen. While Japan has done much over the years to hedge against yen strength by spreading its production network throughout the Asia-Pacific region--"Factory Asia" some call it--ultimately corporate earnings must be reported in yen. And with a strong yen, earnings from abroad become smaller when reported in yen terms.

So here we may have an honest official not out of choice but of necessity. Among other things, he discusses how Japan's economy is every bit as crappy as those of the US and Europe in so many words:

Japanese currency tsar Takehiko Nakao said on Monday that current exchange rates do not reflect economic fundamentals and there is no reason for markets to regard the yen as a safe-haven currency. The yen has risen sharply despite Japan's difficult fiscal situation and the fact that the economy is suffering from the effects of the March earthquake, Nakao, vice minister of finance for international affairs, said in a symposium.

"Of course people can say the yen's rapid appreciation reflects a weak American economy and problems in the euro system, but the Japanese economy is also suffering from the earthquake and also we are in a very difficult fiscal situation and also a sustained economic slump...In my view there is no reason for the yen to be regarded as a kind of safe-haven currency," he said, adding that is why Japan has intervened in the currency market three times since last year to discourage speculative moves.

There is no reason for exchange rates to move in the way they now do and they do not really reflect economic fundamentals, he said. Japan has intervened in the currency market twice on its own and once jointly with other Group of Seven nations [after the aforementioned earthquake] since September last year to stem a rise in the yen that has damaged its crucial export sector and threatened to derail the country's economic recovery.

While Nakao may be the first official of his sort tasked with self-deprecation, let's think otherwise especially past the near-term. Japan being the most advanced and second largest economy in the world's fastest-growing region isn't going to change given the absence of near-competitors. Geography doesn't change, and there are advantages being (nearly) at the centre of it all. The deflationary situation in Japan is also harder to reverse given its worse demographic outlook than either the US or most of Europe. Demography doesn't change when set into motion, either. And once more, FX repatriation on a set basis will always be a fact of life for a chronic surplus-running nation. Given that the yen is freely traded while the yuan is not, we know which will bear the brunt. (Ironically it may be FX repatriation ramping up post-earthquake that's resulting in yen strength, but I'd like to see a year's worth of capital flow data before deriving such a conclusion.)

So there are real mitigating factors to Nakao trying to heap scorn on...his own nation's economy. While the yen certainly looks overvalued--I have no qualms about intervention at this time-- there are legitimate reasons why people are placing bets on it as opposed to the dollar or the euro.