Yen's rise dampens a nation's rally

Investors in Japan who have bagged the biggest profits among major equity markets this year are now apparently getting too much of a good thing.

The yen - Japan's currency - has surged about 12 percent against the dollar since July. Although that makes Tokyo equities and other yen-priced assets more valuable for foreign investors, it also raises the price of Japan's exports.

So after soaring for months, blue-chip exporters like auto companies and electronics firms are leading the equity market down.

Since setting a 1999 peak in July, the Nikkei 225 average has fallen more than 4 percent. Meanwhile, the searing ascent of the yen shows no sign of cooling as the Bank of Japan shies from a major intervention in currency markets.

More broadly, Japan holds the world's largest current account surplus; the United States, the largest current account deficit. Driven by those two extremes, the currencies are finding a new equilibrium with a stronger yen, say economists.

"A stronger yen is a vote of confidence that Japan is finally grappling with its many problems," says Sung Won Sohn, chief economist at Wells Fargo & Co. But "the last thing a country struggling to come out of a recession needs is a stronger currency," he says.

The faltering stock market especially undercuts foreign investors.

While Japanese institutions and individual investors have sat on the sidelines, foreigners have driven the stock market up. They have bought into mergers, sweeping corporate restructuring at many leading firms, and other efforts toward economic revival from Japan's worst slump in 50 years.

Some glimmerings suggest foreigners have made a good bet. Consumer spending, housing investment, and corporate profits are moving up. Gross domestic product (GDP) grew in the first half of the year by 4.5 percent.

But even leading Japanese officials who have minimized the economy's weakness throughout the 1990s now say the recovery is shaky. "The economy still stands on soft ground," Taichi Sakaiya, director of the Economic Planning Agency, said recently.

Falling wages and rising, record-setting unemployment threaten consumer spending, the economy's biggest engine. Capital spending during the second quarter shrank by 15 percent.

And Japanese bank lending in July slumped at a record 6.5 percent.

Banking sector "problems are as grim as they have ever been," says Carl Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y.

The debt-hobbled sector "precludes economic recovery," he adds. "We have never seen a sustained economic expansion without an accommodating increase in domestic credit."

Bad loans of major banks total 7 percent of GDP, far above the roughly 3 percent of GDP spent to clean up the savings-and-loan crisis in the United States.

Despite the lingering malaise, foreign money continues to flow into Japan, albeit at a slower pace than earlier this year.

Many portfolio managers in the United States and elsewhere overseas had severely cut back in Japanese stocks this decade and now don't want to miss a spectacular rebound.

"We're optimistic and overweight on Japan," says Lilia Clemente, manager of the Citizens Global Equity Fund. "The economy is moving into recovery, even though at a snail's pace," she says.

Restructuring among major banks and exporters is especially encouraging. "It's not just window dressing - it's real," says Ms. Clemente, chief executive officer of Clemente Capital Inc. in New York.

As the economy showed signs of revival in the past several weeks, Clemente has bought cyclical stocks with exposure to the domestic market, including firms involved in retailing and consumer finance, she says.

(c) Copyright 1999. The Christian Science Publishing Society