EDITORIAL: Impact of rising yen

The vulnerability of the domestic economy has once again been amply demonstrated with the current turmoil in financial markets. Japan's stock markets have gone into a tailspin as the yen continues to rise against the U.S. dollar.

The benchmark Nikkei stock average closed Wednesday at 13,504.51, its lowest finish in more than two years. Meanwhile, the yen strengthened against the dollar. At one point, the greenback traded at below 106 yen in Tokyo.

Throughout the current phase of economic expansion, the longest uninterrupted growth period in postwar Japan, consumer spending, the central component of domestic demand, has remained lackluster. That is not surprising considering the stagnant paycheck growth. The expansion has been driven almost solely by strong exports, which have boosted profits at many manufacturers and triggered a spurt in business investment. But this dependence on exports for growth has made the economy disturbingly vulnerable.

With the U.S. economy now faltering, raising concerns about Japanese exports, it is only to be expected that the Tokyo Stock Exchange would be hit.

Foreign investors account for 60 to 70 percent of transactions on the Tokyo stock market. But they are pulling out of the weak Tokyo market and pouring their money into rising markets in countries like China and India. Their flight has accelerated the downslide in Tokyo. This has highlighted the Japanese equity market's vulnerability stemming from its dependence on foreign investors.

In the meantime, the ripple effects of the collapse of the U.S. subprime mortgage market for low income earners, the ground zero of the global credit crisis, are beginning to take a toll.

In December, the U.S. unemployment rate rose to 5 percent. The Christmas shopping season was the most sluggish in five years as credit card arrears began piling up rapidly. These and other indicators are causing concern that consumer spending, which contributes to 70 percent of U.S. economic output, is losing steam.

Some leading U.S. banks and brokerages have again announced huge losses for the October-December quarter. To prevent the gloomy news from roiling the markets further, these financial institutions have decided to seek fresh cash infusions from investors in the Middle East and Asia.

Mizuho Corporate Bank has announced it will invest some 130 billion yen in Merrill Lynch. The Japanese bank appears to judge this is a good long-term investment. The move is expected to be a sign that the Japanese banking giant has emerged from the morass of bad loans and regained financial health.

There is little chance that a big U.S. financial firm will collapse or the dollar will crash. But the problems of the U.S. economy should be much more serious than previously thought, given the way the fallout of the subprime credit debacle is spreading. The U.S. economic situation will likely get worse. Some analysts are predicting negative growth in the first half of this year.

What should Japan do to prepare itself for a prolonged economic slowdown in the United States? Some support for the Japanese economy will probably come from exports to emerging countries like China and India, whose economies are robust. Still, Japan needs to figure out new ways to lay a solid foundation for growth.

One thing that must be done, and quickly, is to break the sense of stagnation in national politics. The latest stock market retreat can be blamed, to a considerable extent, on Prime Minister Yasuo Fukuda's passive political posture. The ruling and opposition camps should do more to regain public trust in politics to overcome the current legislative gridlock due to the Diet situation, in which different parties control each house, and push through vital reforms speedily.

Japanese companies, which for years enjoyed a balmy business climate due to an extremely weak yen, should reflect seriously on their failure to end their dependence on exports. A stronger yen will provide an incentive for companies to make more efforts to make themselves less dependent on overseas markets and mitigate the effects of soaring oil and grain prices.

Japan needs to take this opportunity to promote the reforms needed to achieve economic growth driven by domestic demand. One key challenge is how to improve the low productivity in the service sector.

--The Asahi Shimbun, Jan. 17(IHT/Asahi: January 18,2008)