Japanese Yen: An Excessively Strong Currency Spells Recession

Includes: EWJ, FXY
by: Lok Sang Ho

Japan saw its industrial output falling 8.1 percent from October. Another 8 percent decline is expected in December. The chief economist at Macquarie Securities in Tokyo says, "Exports and industrial production are falling so extraordinarily quickly that it almost defies analysis."

The Yen is extraordinarily strong this year, having appreciated close to 25-30% against a basket of currencies. If such strength is not corrected, the Japanese economy would fall into a deep recession quite independently of the financial market turmoil. With the financial tsunami still in full force, the Japanese economy stands no chance with the strong Yen.

There are people who claim that exchange rates should be left to the market. But history tells us that market-driven exchange rates can defy economic fundamentals, leading to significant disruptions to the real economy. Exchange rates are known to be very sensitive to short term capital movements which are also known to swing wildly. This is why James Tobin suggested the "Tobin Tax," a minute tax on forex transactions which will yield the revenue that can be used to counteract any major disruptive exchange rate fluctuations. If exchange rates were determined only by current account transactions, exchange rates would never go out of line with economic fundamentals and could therefore be left to the free market. Unfortunately, these days short term capital movements easily dominate forex transactions originating from current account transactions.

The counterpart of a very strong currency is weak currencies. Evidently, currencies cannot be all weak or all strong at the same time. What I am saying is that exchange rates have to be within a certain range for all economies to prosper. The major economies have to work together to ensure this. If the Group of Five could work together to depreciate the "Super Dollar" in 1985, so the major nations today can and should work together to stem the surge of the super Yen.