Falling bond buying and rising yen present Japan with age-old problem

http://www.guardian.co.uk/business/economics-blog/2012/aug/31/japan-yen-bond-buying-problem

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Japan is a safe haven for global investors. So much so that the yen has soared in value.

Government pride that the country is loved by currency traders is offset by the resulting high value of the yen. Exports are already being hit.

On a visit to London this week, Japan's top currency official said the time may have come to intervene.

Takehiko Nakao, vice finance minister for international affairs, said in a speech in London: "Exports have been influenced by supply chain changes and problems in Europe, some advanced economies and also in China. And we are also suffering from a very appreciated yen ... If needed we will take very decisive action in the market, that is our stance."

Nakao is upset that the euro, which once challenged the yen and dollar as a safe haven, is now considered a joke. He wants the European Central Bank to make good on a pledge to buy Spanish and Italian sovereign debt to reassure global markets that it will protect all 17 members of the eurozone

Reuters reported that Tokyo spent a record ¥8tn (£64bn) in unilateral intervention in the currency market last autumn when the dollar hit a record low of ¥75.31, and another ¥1tn later in that year on undeclared forays.

The yen has risen almost a third since 2007, Nakao said. The dollar has lost around 7.5% against the yen in the last five months alone.

Exports of Japanese manufactured goods are already expensive compared with Chinese and Korean equivalents. A high yen compounds the problem. One of Kyocera's solar panels can set back an environmentally conscious consumer twice as much as a Chinese rival. It will have 25 years of quality control tests behind it and a longer guarantee, but the up-front cost can be the difference between a sale and no sale.

One response by ministers has been to subsidise local purchases. Solar panels are a case in point. With nuclear out of favour, the government has embarked on a huge solar panel installation programme. It's a fantastic plan from an environmental point of view, and probably helps Kyocera's profits, but needs to be paid for.

The Japanese have proved reluctant to agree to rises in taxes since the 1990 property crash and have only just conceded to a rise in VAT from 5% to 8%. A lack of tax revenue to fund investment has forced the government to run up higher debts. Japan's debt to GDP ratio is the highest in the developed world at more than 200%. Luckily for the government it has an implicit, unwritten agreement with Japanese families, which is that all the money they don't pay in taxes must be invested in government bonds. Thereby government spending is not financed by tax revenues but from IOUs to Japanese investors.

But this scheme is running out of steam. The ageing population is drawing more from its pensions and savings than it is squirrelling away. Therefore the capacity of Japanese households to buy bonds is diminishing.

Nakao says the answer is monetary intervention in the form of currency selling to drive down the price. But yet again we are listening to an official reaching for a monetary policy solution when there are more fundamental reasons for the high value of the yen.

They need to think of another way to organise the economy than via an export drive that recycles the profits into state spending via government bond buying.