Its 9,000km away, but Brexit has hit Japan hard

Britains decision to leave the European Union has sent stock

markets and currencies across the globe somersaulting. But the
changes are particularly pronounced and worrying in Japan, where
Brexit has caused the yen to strengthen more than any other major
currency and where the Nikkei 225 last Friday plunged more than
any index outside of Europe, its worst drop in five years.

Image: Washington Post

In the 24 hours after Brexit, Japan lost nearly the same amount of
wealth as after the 2011 nuclear meltdown that threatened to leave a
wide part of the country uninhabitable. (The Nikkei bounced back a
little Monday and continued to rise Tuesday, gaining .92 percent.)

Last weeks British referendum vote created a surge of global

uncertainty not seen since the 2008 financial crisis. But where many
countries are most concerned about new trade barriers and political
instability across Europe, Japan is bracing for the Brexit pain
because of its currency, which tends to strengthen any time investors
worry about the worlds path. And Japan, to put it bluntly, does not
want a strong yen.
Countries typically have a degree of control over the value of their
currencies. But theres just one problem: Economists fear Japan is
nearly out of tools to fight back and deflate the yen.

The story of how the worlds third-largest economy arrived in such a

vulnerable place is directly linked to its strategy over the past few
years, when Japan like many advanced countries was using
every last policy tool just to muddle along, in this case by keeping its
currency as weak as possible.

Well before the Brexit, the Bank of Japan was on an unprecedented

bond-buying binge. Interest rates were already negative. And for all
this, Japan had earned itself an unsatisfying half-recovery, where
wages were stagnant and growth was flat but at least its big
export-heavy titans were raking in record profits. The Nikkei between
2012 and 2015 had been one of the worlds fastest-growing stock
markets the one economic achievement for Prime Minister Shinzo
Abe, who had pledged to pull Japan out of its two-decade stagnation.

But Japan earned that recovery by making a risky bargain: Its central
bank was using crisis-time tools during a period of relative tranquility,
meaning it had little in its pocket to combat the next crisis.

Now, theres not much the Bank of Japan can do to help the
situation, said Takuji Okubo, the chief economist at Japan Macro
Advisors in Tokyo. We could argue that the Bank of Japan has
nearly exhausted its means to ease monetary conditions.
Image: Washington Post

Because Japan is such a big exporter, many of the nations

corporations think Toyota, Mitsubishi and Toshiba receive the
bulk of their income in foreign currency. When the yen gains, their
profits erode. Take the example of Toyota, which manufactures cars
at several major plants across the United States.

On the morning of the Brexit vote, $1 million earned in the U.S. would
be 106 million yen back home. Twenty-four hours later, that same $1
million had the value of 102 million yen.

Because Japan is so export-heavy, its stock market and currency as

a general rule move together; a weaker yen drives the market
upward. But the yen tends to strengthen during times of global
uncertainty because investors view the nation as a safe bet; Japan is
the worlds largest creditor nation.

Typically, Japans central bank could fight back with some form or
easing say, by gobbling up more government bonds. But already,
the Bank of Japan is buying up bonds far more quickly than the
government is willing to issue them. In 2010, Japans central bank
held about 8 percent of the government market. Now, its share is 37
percent, and due soon to rise to 50 percent.
Some economists say that the Bank of Japan is already too
dominating a presence in the bond market and is drying up liquidity
for other investors and banks. The Bank of Japan holds 426 trillion
yen in assets, mostly government bonds. That figure is roughly three
times what it was when Abe came to power in December 2012.

To keep the BOJ share of bonds low, the government could also
speed up its issuance of bonds so the government is creating
them just as rapidly as the central bank is grabbing them. But that
would increase the debt for what is already one of the worlds most
indebted nations.

Japan could also play with its currency another way by having its
government sell yen for dollars, in a unilateral intervention that some
media in Tokyo have speculated could happen soon. But here, the
obstacle is largely political.

G7 countries, including the U.S., the U.K., Japan and others, have an
agreement to manage their currencies together, and Japan would be
likely to catch heat from Washington if its government staged a yen
sell-off. After a G7 meeting last month in the Japanese city of Sendai,
Treasury Secretary Jack Lew emphasized in a statement the
importance of reaffirming our exchange rate commitments, including
our agreement to consult closely with one another and to refrain from
competitive devaluation. On the trail, both Hillary Clinton and Donald
Trump have taken aim at Japan as a currency manipulator.

Even before the Brexit, the yen was gaining value, in large part
because investors had determined that Japan was losing the ability
to weaken its currency. Earlier this month, Toyota had said a
strengthening yen could trim its profits by one-third. Now, Japan has
a currency that is strengthening faster than nearly any on the planet,
and with room to grow more. At the beginning of the year, 120 yen
fetched $1. Now, 100 yen can be traded for a dollar. Okubo said he
wouldn't be surprised if, soon, the dollar hits 85 yen, a level unseen
during the Abe years.

Once the yen starts to strengthen it could actually go a long way,

Okubo said.