Yen Slips, Japan Frets

How the mighty yen has fallen - and keeps falling.

The Japanese currency fell yesterday to a seven-year low against the American dollar. One dollar bought 140.73 yen, a hefty increase from the 112 yen it bought a year ago.

The yen's slide produces more than just ski-slope graphs. It means that the Toyota you've had your eye on will get cheaper. But it also sets off a chain reaction that could further unsettle Asia's wobbly economies, hurt American manufacturers, and swell Japan's trade deficit with the United States, something politicians are already grumbling about.

And the slide may not be over.

"We are targeting 150 [yen] in 12 months," says Ron Bevacqua, an economist at Merrill Lynch Japan in Tokyo. Others say a dollar might buy as much as 180 yen by the end of the year.

On the face of it, a weak yen is good news for Japan. It means Japanese exports become cheaper. One solution to the country's long recession is to export its way to economic health, and a weaker currency makes this easier.

But this scenario has problems. Almost 40 percent of Japan's exports go to its Asian neighbors, who are wrestling with tough economic problems of their own. For countries like South Korea, under an International Monetary Fund restructuring plan, cheaper Toyotas won't help. There isn't enough money to buy.

Not only are a big chunk of Japan's customers too poor to buy, but the yen's slide could make them even poorer. It is bound to makes Asian exports to Japan more expensive at a time when Japanese consumers already are cutting back on purchases.

One answer is for Asian countries to devalue their own currencies to make their exports more affordable and therefore more attractive. But this could start a vicious circle of devaluation and instability, something that has economists worried. It could also swamp the US with cheap imports - nice for consumers, but worrying to American manufacturers, who would have to compete.

So far, the US hasn't seemed overly concerned. In fact, Monday's drop in the yen came in response to comments by Treasury Secretary Robert Rubin. He told reporters that the Group of Eight industrialized nations meeting in Paris this weekend will focus on Russia's financial crisis, not on exchange rates.

Traders everywhere interpreted this to mean that Mr. Rubin didn't mind the yen's weakness, and sold yen.

Last month an American magazine published a widely quoted unsourced report saying that Secretary Rubin was more than happy to let the yen fall if it keeps the world's second-largest economy from crashing. The Treasury Department didn't deny it, and that pushed the yen lower. "To me, the only surprise was that it was a surprise," economist Bevacqua says. "It's basically been US policy for the last three years. But they're not just doing it out of goodness of their own heart."

Keeping the dollar strong is a low-key way for the US to keep a check on growth. With unemployment at a 28-year low of 4.3 percent, the risk of inflation has increased. One way to slow things down is to let the dollar get stronger. An interest-rate hike would also do the job, but it's a less-attractive option because it would have a much more abrupt effect on the economy.

The result of this scenario is that both Japan and the US benefit in the short term from the weak yen. But Japan's leaders are clearly worried about the long term. "We will not tolerate [this situation]," Finance Minister Hikaru Matsunaga said yesterday.

Japan may have little choice. It has already spent billions of yen trying to prop up its currency to no avail. Many say what is needed are fundamental reforms in the Japanese economy.

"To get out of this dead-end situation, Japan needs budgetary reform, financial reform, and more deregulation," says Susumu Takahashi, chief economist at the Japan Research Institute in Tokyo. "Unless the structure here changes, we'll just see the same old vicious circle."