Bank of Japan without governor -- Will recession follow?

March 14, 2008

Japan’s new Prime MInister, Yasuo Fukuda, is trying to replace the current governor of the Bank of Japan (BOJ), Toshihiko Fukui, before he steps down March 19. His choice, Toshiro Muto, is a deputy governor at the bank who is being rejected by the opposition party. They feel that Muto's former position in the Ministry of Finance could jeopardize the ability of the Bank to remain independent.

Without strong economic leadership at the Bank, Japan's economy could sink into recession. That's because the recent dollar decline has strengthened the yen to 1995 levels. As a result, Japan's exports have become expensive, threatening to slow economic growth to below the 2% GDP growth rate it has only recently achieved.

For example, every time the dollar's value declines by one yent, Toyota loses 35 billion yen in profit. The dollar has declined10 yen so far this year, cutting into Toyota's profits by several billion dollars. Toyota's president, Katsuaki Watanabe, said the company could lose profit growth if the dollar continues to slide, despite cost cuts. (Source: WSJ, Japan Economy Quakes Anew as Yen Soars Against Dollar, March 14, 2008; IHT, Lawmakers Reject Nominee for Bank of Japan, March 12, 2008)

What the Bank of Japan leadership vacuum means:

The Bank of Japan had been reversing its recent policy of zero interest rates. The zero rate was needed to reverse Japan’s deflation and low economic growth. As Japan’s economy recovered, the BOJ raised rates to .5%. This has reduced the ability of traders to profit from the yen carry trade. Global traders borrowed yen at .5%, to invest in currencies such as the dollar that paid a higher rate of return (around 5%.) (See BOJ to raise interest rate, 7/12/06 )

However, as the Fed lowered interest rates, and the dollar became cheaper, this source of liquidity has dried up. This means less investing worldwide, and economies will continue to slow. The Bank of Japan may need to buy more U.S. Treasuries to support the dollar, keep the value of the yen low, and keep Japan's exports competitive. Without strong BOJ leadership, Japan could drift into recession, and possibly even the deflation that hobbled it in the 1990's.

Action steps:
A vacuum in leadership at the Bank of Japan at this critical time could also contribute to further dollar decline. Find out how to protect your personal finance with the WorldMoneyWatch Special Report, “The Dollar Collapse."

Yen carry trade related articles

Japan Economy Stagnating

G7 ignores weak yen, 2/14/07

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