Japan Economy Quakes Anew
As Yen Soars Against Dollar

Political Gridlock
Hits Tokyo Stocks;
An Upside for U.S.?

By YUKA HAYASHI and JOANNA SLATER
March 14, 2008; Page A1

The dollar's dive deepened, as it touched a low against the euro and, for the first time since late 1995, briefly bought fewer than 100 yen.

The weak greenback creates a host of problems world-wide, starting in Japan, where a stronger yen threatens exporters and makes a slowdown or recession more likely in the world's No. 2 economy.

Japan is again suffering from a broad sense of drift, after momentum built up under charismatic Prime Minister Junichiro Koizumi, in power from 2001 to 2006. Parliament, split between the two big parties since last year, is in gridlock, leaving the country without a central-bank governor less than a week before the incumbent steps down. The benchmark Nikkei Stock Average is down 19% for the year.

Despite the blow it delivers to Japan, the dollar's steep decline is welcomed by some economists, who say it could help the U.S. reduce its huge trade deficit and thereby shake its $2 billion-a-day addiction to foreign capital. "I think a weaker dollar, if it doesn't spiral out of control, is part of the solution here," said Barry Eichengreen, an economic historian at the University of California, Berkeley.

Prof. Eichengreen's "if" is a big one. The fear now is that the dollar's decline could accelerate and that could shake already rattled markets. Gold, a refuge in times of uncertainty, briefly topped $1,000 an ounce yesterday in one contract, while the benchmark crude-oil futures price topped $110 a barrel.

The U.S. Federal Reserve is facing both a weakening economy and inflationary pressures brought on by higher oil and commodity prices. If the Fed cuts rates sharply even as the European Central Bank and Bank of Japan are holding them steady, that could intensify downward pressure on the dollar, and add to anxiety about U.S. inflation. The dollar tends to weaken as U.S. rates fall relative to overseas rates, because the other currencies become more attractive to investors.

For Japan, the reverberations from a weak dollar come at a particularly vulnerable time. Despite six years of modest growth, consumers still haven't opened up their purse strings. The Bank of Japan's benchmark interest rate remains at 0.5%.

In Mr. Koizumi's final year, it seemed possible that Japan would finally escape the specter of deflation -- constantly falling prices -- that had acted as a brake on growth since the late 1990s. The Bank of Japan hoped to raise interest rates to a more normal level, to give itself more flexibility.

Instead, it is stuck: It can't raise rates when the economy's outlook is weak, nor can it lower them much. More creative steps by the BOJ are off the table until it gets a permanent new governor.

Investors' waning confidence in Japan has sent stocks sinking. The Nikkei has fallen more sharply than the Dow Jones Industrial Average, even though cautious Japanese banks generally sidestepped major damage from the U.S. housing mess. The Nikkei fell 3.3% yesterday, dragging down Asian shares, and the index stands at less than one-third of its peak in 1989.

"Unless drastic restructuring is done, the economy will wither in the medium- to long-term," said Eisuke Sakakibara, a Waseda University professor and former finance ministry official who recently published a book titled "Japan Goes to the Dogs."

Japan is particularly vulnerable to currency fluctuations because its economy depends so heavily on exports for growth. Japan's economy grew by 2.1% last year, and more than half of that growth came from exports. A weaker dollar makes Japanese companies' products more expensive overseas, while reducing the value of their dollar-based earnings when converted into yen.

If the dollar continues to fall, "we now face a considerably high possibility of having a situation that can be defined as a recession," said Hiroshi Shiraishi, a Lehman Brothers economist in Tokyo.

Toyota Motor Corp. sees annual operating profit cut by 35 billion yen, or about $350 million, every time the dollar's value slips by one yen. With the dollar having lost more than 10 yen since the end of last year, that suggests Toyota's profits could take a several-billion-dollar hit. The car maker's president, Katsuaki Watanabe, told reporters yesterday it isn't clear if the company could maintain profit growth if the dollar continues to slide, despite cost cuts and other possible measures.

The last time Japan faced a seriously weak dollar was in 1994 and 1995, when the dollar stayed below the 100-yen level for a year and a half, and reached a historic low of 79.75 yen. Japan fought back by intervening heavily in the currency markets to depress the value of the yen and boosted government spending to help weaker companies.

This time, Japan doesn't have as many tools. Its big budget deficit makes a stimulus package more difficult. Intervention -- which Tokyo also tried in 2004 during a bout of yen strength -- would fly in the face of efforts by the U.S. and other nations to let markets decide currency values.

The dollar's decline isn't all bad news for the Japanese economy, especially for consumers who can expect bargains on imported handbags and the like. However, food, raw materials and energy make up a big portion of Japan's imports, and prices of these goods are going up, even accounting for the cheaper dollar.

"Savings from the strong yen in no way offset the damage from the rise in commodity prices," says a spokesman for Nissin Food Products Co., a big instant noodle maker and a major importer of wheat.

Over the past year, wheat prices have more than doubled. Nissin expects higher ingredient costs to shave at least three billion yen off its earnings for the year ending March 31. It anticipates "far greater losses" going forward, the spokesman says.

In Europe, too, policy makers and businesspeople are generally focusing on the downside of the dollar's slide and its effect on exports. A February survey of purchasing managers in the countries using the euro found that the growth in new export orders rose at the weakest pace for 33 months.

Early in the life of the unified European currency, one euro bought less than a dollar. At yesterday's record level, a euro bought more than $1.56. Since the start of 2002, the dollar has lost 25% of its value measured against a trade-weighted basket of 26 currencies.

The dollar's slide is likely to continue, say investors, unless Europe's economy shows significant signs of weakening or governments intervene in currency markets. The dollar's fall is "still orderly, but it's becoming a bit worrisome," said Stephen Jen, global head of currency research at Morgan Stanley. "Speculators are deploying capital and leverage to capitalize on the vulnerabilities of the U.S. dollar."

The good news is that currency markets remain highly traded, with none of the freezing-up that has characterized large swaths of the credit markets. Contracts used to protect against swings in currency values indicate that investors are worried about near-term volatility, but not nearly as much as they were during earlier bouts of instability in 1998 and 2000, says Greg Anderson, a foreign-exchange specialist at Dutch bank ABN Amro.

Berkeley's Prof. Eichengreen says "it would have been nicer" if the dollar's fall wasn't accompanied by "everything coming with a crash all at once." But he still sees a bright side for the U.S.: "When consumer demand is weak and investment demand is weak, the one remaining source of demand is export demand, and that's what a weak dollar stimulates."

--Joellen Perry, John Murphy and Justin Lahart contributed to this article.

Write to Yuka Hayashi at yuka.hayashi@wsj.com and Joanna Slater at joanna.slater@wsj.com

Japan Economy Quakes Anew As Yen Soars Against Dollar

Japan Economy Quakes Anew
As Yen Soars Against Dollar