Bank of Japan building in TokyoShizuo Kambayashi
Japan sought to rescue its flagging economy with a package of stimulus measures, but the move failed to achieve its No. 1 objective: to cool the rising yen that threatens to cause havoc in its crucial export sector.
The world's third-largest economy has been stuck in neutral or reverse for much of the past two decades, yet its currency has recently soared to heights last reached 15 years ago, as worries mount over the increasingly fragile U.S. and global recoveries.
To cure that, Japanese officials signalled that they would adopt aggressive measures to curb the yen's attraction. But speculators quickly concluded that the Bank of Japan was firing blanks after it announced yesterday that it was expanding a ¥20-trillion ($236-billion) bank credit program by one-third.
Prime Minister Naoto Kan later pledged to direct ¥920-billion into efforts to boost domestic demand.
Immediately following the announcement, the yen began rising against most of the world's major currencies, including the U.S. dollar and the euro. Japan's currency has risen about 12 per cent against the greenback since early April; $1 equals about 84.5 yen.
The Japanese paradox - a hot currency in a weak economy - has even some foreign exchange traders scratching their heads.
But veteran Japan watchers and currency analysts say the yen has even more to room to rise in a time of growing risk aversion and worsening trade imbalances and that officials may be helpless to stop it from creating fresh problems in an already ailing Japanese economy.
"It was probably about the bare minimum" the central bank could have done, said David Watt, senior fixed-income and currency strategist with RBC Dominion Securities. "People went from being fearful of what they might do to no longer being fearful, at least for now."
About 40 per cent of Japanese manufacturers warned in a recent survey that they would shift more capacity abroad if the yen stayed at or near current levels against the U.S. dollar and other major currencies.
But the yen is not about to come tumbling down, without massive government intervention, combined with help from other central banks, which seems extremely unlikely.
As things stand, Japan's continuing trade surpluses and high domestic savings rate make it one of the few providers of global capital, and its currency continues to be viewed, along with the Swiss franc and U.S. dollar, as a safe harbour in a sea of deepening uncertainty.
Even the Chinese have been loading up on Japanese bonds, as part of Beijing's efforts to diversify its vast foreign exchange reserves. A stronger Japanese yen also serves China's political and economic interests, as Japanese manufacturers are forced to move more capacity outside Japan.
The forces at work behind the yen's surge "are very strong and they're going to get stronger," said Peter Zeihan, vice-president of strategic analysis with Stratfor, a global intelligence firm based in Austin, Tex.
These include Japan's famously aging and shrinking population, which means steadily falling consumption and hence declining imports. Combine that with steady exports and the result will be balance-of-payments surpluses for years to come.
The Japanese are holding a lot of foreign assets, including bonds and equities, and some of this capital is being repatriated into the Japanese market, over fears that the global recovery is sputtering to a halt.
The yen's spectacular climb came to a brief halt when news broke over the weekend that the Bank of Japan was holding an emergency meeting to respond to the currency's sharp rise.
The market is now engaged in a game of cat-and-mouse with Japanese officials.
"Are you going to do anything more severe, are you going to do anything to combat deflation? And if you aren't, then we're not going to be fearful of buying yen," Mr. Watt said.
The Japanese showed they are "just going back to the old playbook and calling the same plays that didn't work before and don't seem likely to work this time," Mr. Watt said. "So the market is just not fearful."
The government could intervene directly by buying up U.S, dollars or cranking up the printing presses - both of which would flood the market with yen. But these are strategies fraught with peril and unlikely to draw the necessary support of other central banks.
"The scope of intervention would have to be truly awesome, and nobody is going to assist them with that," Mr. Zeihan said.
But although Japan, along with other developed countries, has made a commitment to let the market determine the value of its currency, it may well not live up to that pledge, if its economic woes worsen.
"It's not like there's anybody out there to call the kettle black," Mr. Zeihan said.