David Pilling, FT Syndication Service
TOKYO: In 1985, Japan was considered so menacing an exporter that the US ganged up with West Germany, the UK and France to force a revaluation of the yen. Two years after Tokyo was roughed up in New York's Plaza Hotel, the Japanese currency had doubled in value from Y240 to the dollar to around Y120.
These days, China has replaced Japan as the world's trade-surplus bogeyman of choice. Yet by some measures, Japan is just as formidable a competitor as it was in the mid-1980s when massive intervention was considered to be the only means of stopping the onslaught of Japanese exporters.
In the first quarter of this year, exports accounted for 17 per cent of Japan's nominal gross domestic product (GDP), according to Nikko Citigroup, compared with 14.1 per cent in the third quarter of 1985. And Bank of Japan statisticians say the real, inflation-adjusted value of the yen is precisely where it was back in September 1985, on the eve of the Plaza Accord.
Almost all economists agree that exports have been the main driver of Japan's five-year recovery. Over that period, the trade surplus has quadrupled from 1.0 per cent of GDP to 4.3 per cent.
The weak yen is by no means the only reason for a dynamic export performance buoyed by strong global demand and the rapid industrialisation of China. But it has not hurt. Since 2002 - and contrary to normal behaviour during a lengthy expansion - the yen has fallen about 15 per cent in real terms.
The weakening currency has made Japanese exports more competitive still and provided a windfall for exporters booking profits in yen. That in turn has spurred investment in plant and equipment. This week, strong first-quarter capital spending, up 13.6 per cent from a year earlier for the 16th straight quarterly rise, helped ease recent concerns about weak machinery order numbers.
As recently as March, some excitable voices had been predicting the end of the ride. As global equity markets reeled, there was talk of an end to the so-called carry trade, through which investors sell yen to invest in higher-yielding currencies. If that money suddenly flowed back, warned some doomsayers, the yen would strengthen overnight, damaging Japan's strongest growth engine.
That did not happen. After a short-lived rally, in which the yen strengthened to Y115 to the dollar, the currency continued its genteel slide. Last Tuesday, it was trading at about Y122 to the dollar and a record low of Y164.30 to the euro. JPMorgan predicts that, by midsummer, the yen is likely to have weakened further, possibly reaching Y125 or Y126 to the dollar.
"It's a very benign environment for Japan right now," says Masamichi Adachi, senior economist at JPMorgan. "The US is recovering and the weakening yen is contributing to higher profits. It is difficult to see the Japanese corporate sector losing momentum."
There are two main reasons for optimism. The first relates to international interest rates. Both the European and the US economies are fairly strong, making a near-term rate cut unlikely. Interest rates in Japan are rising, but extremely slowly. Headline prices are falling, making it hard for the central bank to fulfil its ambition of normalising interest rates any time soon.
The bank may well raise rates one more time in late summer to a still modest 0.75 per cent. But that is likely to be its last hurrah for several months. As a result, interest rate differentials will remain wide, encouraging investors to move money from Japan in search of more succulent opportunities abroad.
The second reason relates to political pressure. US and European manufacturers have complained that the weak yen gives Japanese companies an unfair advantage. But few commentators believe that complaints will gain any traction.