global agenda 88.
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In a week filled with important and often dramatic developments across a broad range of markets, perhaps the outstanding event was the sharp rise of the yen. The Japanese currency rose by several percent against the dollar, with a dramatic jump of almost 3% on Wednesday alone, even as the dollar itself gained against most other currencies, so that the yen's move against currencies such as the euro, sterling and Swiss franc was truly massive.
The strength of demand for the Japanese yen seems strange, given the appalling state of the Japanese economy. An excellent overview of the the main East Asian economies, including Japan, was presented by Saul Eslake, the chief economist of Australia's ANZ bank, at a conference in Germany. Although the Japanese data have been amazingly awful for some time, chewing through Eslake's summary caused me to suffer a renewed bout of both shock and horror. It is difficult to believe that a developed economy as large as Japan's - it is still the second largest national economy in the world - could undergo so massive a slide in so short a time.
Eslake began by noting that "Japan is experiencing the most severe contraction of any country in the G7." GDP declined at an annual rate of almost 14% in the half-year from October 2008 through March 2009 - more than double the drop in the US and far more than the EU. Consequently, Japan's economy has shrunk back to the size it was over five years earlier, in September 2003. Half a decade of slow recovery and meager growth were expunged in half a year. Unsurprisingly for Japan, this slump was led by a veritable collapse in export volumes, the like of which has not been seen anywhere else - a 60% annualized fall in the disastrous half year following the collapse of Lehman, when world trade fell off a cliff.
Business investment fell at an annual rate of 30% - half that of exports but still horrendous by any normal standard. These two forces together caused Japanese industrial production to fall by a staggering 35% - NOT annualized - between July 2008 and February 2009. This mind-boggling implosion of Japanese manufacturing output sent the country back in this key economic parameter not five years but THIRTY, with the index of industrial production falling to a level last seen in 1978, when Japan was still making its epic run from developing to developed status.
There is more - a great deal more - in Eslake's review of the woeful state of Japan's economy. Renewed deflation and the highest ratio of government debt to GDP are two more attractions currently sported by the Land of the Rising Sun. How come, then, that it is once again the land of the rising yen? The answer is brutally simple and, if you are short yen, simply brutal. The rate of interest on the yen has been very low for years, making it the currency of choice for speculators to finance their trading activities on global equity, bond, currency and commodity markets. This speculative bubble exploded last year, but there is still plenty of air waiting to leak out - and the bout of further speculation that began in March this year has created another legion of yen borrowers around the world.
In the new environment, borrowers and lenders alike are much jumpier than they used to be, so as soon as it seems things might be going wrong, for any reason, everyone runs for cover. This involves purchasing yen to repay loans and selling the speculative assets those loans were used to finance. The yen is thus the barometer not of the relative weakness or otherwise of the Japanese economy, but rather of the relative fragility of the entire global financial system.