Yen’s Rise Seen as a Threat to Japan Economy

TOKYO —  The hand signals and traders’ antics have been more frenzied than usual recently in Tokyo’s currency pits as the yen mounts a strong run against the dollar.

Although this has boosted trading volumes, those outside trading rooms with a somewhat longer-term view express growing concern that the rise could unhinge recent signs of Japanese economic stability.

The yen’s surge to a five-month high of just under 115 to the dollar Friday, from more than 122 three weeks ago, has been fueled by growing belief that a Japanese economic recovery is in sight. In part, that is driving demand for yen by foreign investors to invest in Japanese stocks, which surged to near two-year highs recently before pulling back a bit.

Investors also are betting that Japanese interest rates will rise, which could boost investment in Japanese bonds.

A belief that the “Cinderella” U.S. economy finally is slowing also is working in favor of the yen and against the dollar.

Japan has intervened repeatedly since June in currency markets--a process of buying dollars to prevent the yen from rising--in a bid to keep the yen at the 120 level. But the yen has risen anyway.

The uncertainty gripping Japan was underscored Friday with the announcement that Japan’s unemployment rate hit 4.9%--an all-time high--while worker household spending fell 1.8% in June.

The rising yen threatens the Japanese economy by damaging the country’s exporters, eroding economic confidence and indirectly threatening the financial system.

Although the yen’s recent appreciation against the dollar seems relatively modest in absolute terms, its impact on the Japanese corporate landscape is far greater. Japanese exports have been one of the few bright spots in an otherwise battered economy.

If the yen stays at current levels or strengthens further, it will sharply undercut that profitability by making Japanese exports less competitive in overseas markets. All else being equal, for example, a 4% yen rise adds $1,000 to the sticker price of a $25,000 Japanese-made Toyota sold in the U.S.

Furthermore, while Japan has sought to shift away from the “export or die” mentality it has held over much of the postwar period, progress has been slow. Export companies remain first among equals here with a disproportionate economic and corporate leadership role.

Exporters here have also played a major role in the recent run-up in the stock market, which accounts for some of the mixed optimism. The Nikkei stock index stood Friday at 17,861.86, up 27% from the 14,000 level in March.

Stocks of major exporters such as Sony, Aiwa and Fujitsu have helped pace the rally. If the outlook for exporters’ profits fades, their stocks could sink as well.

Sony’s weak April-June quarterly results announced Wednesday suggest how quickly currency shifts can hit the bottom line.

Sony’s net income tumbled 55% to $158.2 million largely because the yen strengthened to 120 to the dollar, on average, during the quarter, compared with 135 a year earlier.

Companies find it difficult during periods of rapid appreciation to map their near-term future or cut costs quickly enough.

“We have a hard time planning our future,” a Sony official said, requesting anonymity. “Volatile exchange rates can cause unexpected damage to our business results.”

Moreover, another stock market sell-off could hurt Japan’s shaky financial system. Banks awash in red ink from bad real estate-related loans in the late 1980s won a recent reprieve when the stock market rallied, pushing up their capital levels. A fall in stock prices could reverse the process.

The broader Japanese stock market of 1,344 companies, which is up more than 55% since September, has already seen several false dawns this decade. Many analysts argue, however, that this time it’s for real.

Thursday’s June producer index, a measure of company activity, was up a strong 3% for the month, well above the 2% expected. And Japan posted a 1.9% GDP growth rate in the January-March quarter. Such indicators added to general confidence here that the worst is over.

Yet much of the recent improvement is cyclical, argued Hiroshi Kuribayashi, chief analyst with Barclays Capital. Japan still confronts huge debt levels at banks, insurers and companies as well as inefficient employment and distribution systems.

“Unfortunately, the structural side is preventing a real recovery,” he said.

Another looming concern is the continued lack of real economic activity beyond the government’s massive spending program. Public works spending rose 10.3% during the January-March quarter, on the heels of last year’s $203.3-billion supplementary budget earmarked to build new roads, buildings and what critics call boondoggle bridges to nowhere.

At some point, private-sector momentum must pick up the slack or Japan will quickly slip back. Meanwhile, there are fears that the massive government borrowing will push up long-term interest rates. Although the Bank of Japan has done a good job keeping interest rates close to zero, any hike could push highly leveraged companies over the edge.

“When public spending runs out, the economy will turn down again,” said Yasunari Ueno, chief economist with Fuji Securities Co. “I think we’ll see that in the last quarter of this year.”

The many storm clouds provide cold comfort for consumers, whose spending accounts for 60% of the Japanese economy and is key to any protracted recovery.

“It sort of looks like the recession is over,” said Eiji Ohara, a 52-year-old salesman. “But I don’t think it is and [I] have a feeling things will get even worse. I don’t feel like spending much money and don’t have it to spend anyway.”

But others believe the sake cup is half-full and hope for the best. “I don’t believe it can get worse,” said 41-year-old Momoko Yamaguchi, a shipping company secretary. “I believe and hope the recession is finally over.”

All this leaves Japan on very delicate legs, analysts say. Not only does additional yen appreciation threaten the balance, but also any weakness in the U.S. economy would almost certainly knock Japan over--and with it the rest of Asia.

“All eyes are on the U.S.,” said Andrew Shipley, an economist with Schroders.

Etsuko Kawase in The Times’ Tokyo bureau contributed to this report.

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A Rebounding Currency

The Japanese yen has resurged against the U.S. dollar in recent weeks, though it still is below its best levels earlier this year. Yen per dollar, monthly closes and latest:

Friday: 114.48

Source: Bloomberg News