Introduction

In early February 2007, a phalanx of incoming Democratic committee chairmen-Levin, Rangel, Frank, and Dingel-worrying particularly about a 32 percent increase in automobile imports from Japan from 2005 to 2006 and which continue to increase strongly in 2007, wrote a letter to U.S Treasury Secretary Paulson:

"The weak yen reflects (Japanese) monetary and fiscal policies, including setting low interest rates and failing to stimulate consumer demand. We believe that the weak yen is a reflection of Japanese government policy. It reflects the Japanese government's massive intervention earlier in the decade, an intervention which still reverberates in the value of its currency".

On March 30, the Financial Times reported: "A lobbyist for GM, Ford, and Chrysler said the Treasury Secretary needed to be pushed into spearheading a coordinated international effort that would lead to Japan selling down its excess reserves to stimulate a stronger yen".

On July 16, The Japan Times reported that The Bank for International Settlements has issued a warning against the current trend of yen undervaluation. Its Annual Report states, "There is clearly something anomalous in the ongoing decline in the external rate of the yen". In Europe, the financial press has also been full of quotes from politicians complaining about the yen being unduly weak against the euro and pound sterling making Japanese exports too competitive. In its 10 February 2007 issue, The Economist pontificated: "A country with one of the world's largest current-account surpluses and low inflation (but no longer deflation) should have a much stronger currency. Japan's economy is no longer flat on its back. Last year it grew by an estimated 2.3% and is forecast to maintain a similar pace this year. As a result Japan does not need such low interest rates or a super-cheap currency any more. Indeed, Japan's abnormally low interest rates (the short-term interbank rate is just one quarter of one percent) could be viewed as a form of intervention to hold down the yen" (page 77).

The Economist produced a graph showing a sharp fall in the real trade-weighted yen of more than 30 percent over the last eight years. (The euro and pound have appreciated even more against the yen in real terms.) The Economist also showed that, by February 2007, the "real" yen had depreciated just below where it was in 1970-just before the Nixon shock of August 1971 drove the dollar down against all the major currencies.

Without contradicting any of these statistics, I will show that the Japanese have been rather hapless victims of international monetary events. Foreign exchange risk (fear of yen appreciation) has kept Japanese interest rates mired close to zero for more than a decade, and still prevents the Bank of Japan from properly stimulating domestic consumption demand. Even though output resumed growing modestly from 2003 to 2007 after the preceding "lost decade", wages continue to stagnate. The recovery remains so fragile that the Japanese government is divided and uncertain on the question of raising interest rates and strengthening the yen. In this paper, the historical roots of Japan's continuing macroeconomic fragility, resulting in today's syndrome of the ever-weaker yen, are examined.

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