The dramatic decline of the Japanese economy, with a record annualized 12.7% negative growth, is not surprising at all. With the global economy in recession and a much over-valued Yen, export-dependent Japan has no where to go but down. But this will be to the detriment of everybody. An excessively strong Yen goes against the interest of everybody except those who have longed Yen.
Why is Japan so export dependent? Japan has no choice, because Japan has a huge population and has little natural resources. Japan has to import a lot to feed, clothe, and even house its population; that is why it has to export a lot. If Japan's export engine stalls, it cannot simply switch to production for the domestic market, since all the raw materials will have to be imported. Already Japan has been experiencing trade deficits for several months in a row. Its current account surplus, which includes net factor incomes earned overseas, also has been shrinking. With the export sector in shambles and net investment income falling, it is possible that even the current account turn into red.
It is frustrating for me to observe Japanese officials trying to bolster the stock market but doing nothing to avert the senseless appreciation of the Yen. At such levels, almost every manufacturing concern in Japan would fail. Artificially supporting stock prices would not work! But the Bank of Japan can sell Yen; indeed it can sell as much Yen as the market wants. There is no worry this will create excess liquidity, because should the Yen depreciate excessively, and at any sign of inflation, the central bank can mop up the excess Yen just as easily as it had sold the Yen in the first place.
The excessively strong Yen is not helping other countries to export to Japan at all, because when unemployment and bankruptcies are on the rise, Japan's imports can only go down.
In part because Japan's share in world trade is shrinking fast, world trade is also shrinking fast, hurting everybody. Order needs to be restored to the foreign exchange market before the world's second largest economy can have any chance of recovering.
