Yen Keeps Rising as Japan Stocks Hit 26-Year Low

The global credit crunch and market rout are clearly scaring Japanese officials. On Oct. 27, Tokyo took the unusual step of rallying the world's richest nations to warn investors that the Japanese currency's rise to its highest level in years poses a threat to the global economy. In a statement, the Group of Seven specifically singled out the yen's "recent volatility" as a possible factor in undermining "economic and financial stability."

The G-7's show of solidarity came hours after Japan's Finance Minister, Shoichi Nakagawa, used strong language condemning the yen's sharp rise last week to a 13-year high against the dollar and six-year high against the euro. Traders viewed the remarks as a signal that Japanese financial authorities stood ready to intervene for the first time since early 2004.

Action can't come soon enough in the view of many market watchers. "This massive strengthening in the value of the Japanese yen," Standard Chartered Bank (STAN.L) currency analysts wrote in an Oct. 24 report, "is coming at exactly the wrong time." They predicted "it may not be long before we see the Japanese authorities intervene to limit the slide."

Nikkei Index Falls 6.4%

Help may be on the way, but it didn't arrive today. With critics complaining that the comments from Nakagawa and the G-7 had little impact, the yen kept on gaining strength against the dollar, trading at around 93 yen and the euro at 116 yen. The rising yen, combined with concern that plans by Japanese banks to raise capital may dilute shareholdings, knocked Japan's benchmark Nikkei 225 stock index to its lowest level in 26 years. The index finished 6.4% lower, at 7,162.90, a level not seen since October 1982. This month alone, the Nikkei has given up 36%; since January, it has fallen 53%.

The concern is that a strong yen and global slowdown will end up hurting Japanese exports, which have long been the one bright spot in the domestic economy. In the past three months, the yen has risen 19% against the dollar, 32% against the euro, 33% against the British pound, and 37% against the Brazilian real. By contrast, the Korean won is down more than 45% against the dollar this year, giving Korean exporters a leg up (BusinessWeek.com, 10/24/08) on the Japanese.

Unless the yen suddenly retreats, economists think Japan's economy is headed for a recession. "Over the next 12 months, we now expect Japan's gross domestic product to shrink by 0.4%," says Japan Research Institute senior economist Hideki Matsumura.

For months it seemed that Japan's biggest banks had largely avoided the U.S. subprime mortgages-related losses, especially as Japanese financial institutions were buying up ailing rivals. After the collapse of Lehman Brothers, Nomura Securities bought its European and Asian operations, while Mitsubishi UFJ spent $9 billion on a 21% stake in Morgan Stanley (MS).

Bleak Profit Outlooks

But last week, Sony's (SNE) profit warning highlighted the problems Japan Inc., and especially its exporters, faces. The technology giant slashed its annual operating profit forecast (BusinessWeek.com, 10/23/08) by 57%, and said there could be more currency-related pain if the yen holds steady.

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