When politicians discussing the current economic situation tell us "it's likely to get worse before it gets better," it seems they weren't kidding.
Yesterday the U.S. Senate failed to come to an agreement on a $14 billion bailout for the U.S. auto industry, and this morning, the Japanese yen hit a 13-year high against the U.S. dollar, a troubling signal for two of the world's largest economies.
Apart from Germany and China, Japan is the world's preeminent export economy, relying on a weak Yen to peddle its goods to primarily the U.S. market. With slumping demand in the U.S., and the rapid depreciation of the dollar versus the yen, Japan stands to lose out significantly. This has helped to reduce Japan's current account surplus significantly, as exports fall. The drop in the oil price might help in relieving the costs of imports, but a country once known for its massive trade surpluses seems to be losing its edge.
I have argued frequently in favor of a larger role for Japan in the world economy. Too infrequently during the current economic crisis have we seen the kind of leadership that Japan is capable of and responsible for. Perhaps it is the ruling Liberal Democratic Party's precarious political prospects that are discouraging it from taking the risky but potentially rewarding policies needed to stabilize the world economy.
It may be time for a new type of "Plaza Accord," in which the U.S. coordinates with Japan a managed exchange rate revaluation. Only this time, it is the U.S. dollar, not the yen, that is increasingly depreciated and needs propping up. Another factor is that the value of the dollar, of course, has been partially supported by the massive stockpiling of U.S. dollar reserves by China, which itself enjoys a massive trade surplus because of an undervalued, but steadily appreciating, currency. But now, the problem is the Chinese also face the prospects of slower economic growth, primarily due to the American recession. And like Japan, China may face a threat of a political reckoning if it cannot help its people absorb the impact of the global recession.
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