Toyota and the Yen, Part II

In his rebuttal to my Feb. 23 article, "Toyota and the Yen," Stephen J. Collins makes the promising contention that, "U.S. automakers are fully confident that their vehicles can compete successfully in any market in the world." No doubt that's true. Where we disagree is in his assertion that currency manipulation in either Japan or the U.S. will make this possible. The laws of economics haven't changed, and as such, you cannot change the terms of trade by changing the units of account that various goods are priced in.

Collins contends that the "Japanese government never intervenes, either financially or through official government statements to strengthen the yen." The problem there is that in the Sept. 22, 1985, post-Plaza Accord announcement released by the Ministers of Finance and Central Bank Governors of France, Germany, Japan, the United Kingdom, and the United States, it was clearly stated that "some further orderly appreciation of the main non-dollar currencies against the dollar is desirable."

In the aftermath of Plaza, Japan in particular complied. While Collins says Japan's central bank "only manages its currency in one direction to weaken the yen," the reality is that it was trading at 240/dollar in September 1985, and has since risen to 117/dollar, an appreciation of 109 percent. Notably, Collins made no mention of the yen's impressive strength over the last 21 years in his article.

Though he can point to various financial statements and a press conference at which a Toyota executive cited the apparently slightly weaker yen's positive impact on the firm's bottom line, my only reply is that mercantilist ideas are not unique to U.S. executives. Indeed, as my article noted, "the money illusion has sadly captivated economists, politicians and producers for centuries." Mercantilist is not synonymous with American.

Still, perhaps a better way to measure the true impact of a weaker or stronger currency is to see how stock markets price companies supposedly advantaged or disadvantaged by stronger or weaker currencies. If a strong country currency is necessarily harmful to a firm's performance, then by Collins's own reasoning Toyota and Honda would have struggled mightily since 1985, while GM and Ford would have thrived.

The opposite is true. Honda's shares have risen 676 percent since 1985; this amidst a crushing bear market for Japanese stocks that has the Nikkei average down 57 percent from 1989 highs. Toyota's shares have risen 833 percent over the same timeframe.

On the other hand, the Dow Jones Industrial Average is up over 500 percent since 1985, yet Ford's shares have risen a relatively paltry 188 percent from the time that Japan agreed to significantly strengthen the yen. GM's rise is even less impressive; just 21 percent since September 1985.

Far from being harmed by a rising dollar, GM's shares rose 56 percent from June 1997 to May 2000. Much has been made about the yen's slight weakness versus the dollar over the past year, but it didn't seem to hurt GM. While Toyota's shares are up 27 percent since last March, GM's are up a whopping 51 percent.

Later on in the article, Collins makes the point that "Toyota reports its profits in yen, pays its Japanese employees in yen, and pays its suppliers in yen. When the yen depreciates, the dollars or euros that Toyota earns on its exports translate into more yen." No doubt that's true, but it doesn't discuss the certain impact of a weaker yen on profits, employees and suppliers.

If a foot is redefined as 6" in length, I may be 12 feet tall, but I won't be any taller. If Toyota's earnings rise in a depreciated currency, its real earnings will not have risen at all. If the yen depreciates, Japan's suppliers are by definition going to require payment in a greater number of yen. Just the same, with the looming inflationary pressures that will result from a weaker yen, pressures that will ultimately drive up consumer prices in Japan, will Toyota's factory workers really sit idly by if the BOJ devalues without asking for a yen-denominated pay raise?

Importantly, GM CEO Rick Wagoner touched on the difficulties caused by a weak currency in a 2005 Wall Street Journal op-ed. In it, he noted that "the recent surge in gas prices hurt sales." Since June 2001, oil in dollars is up 118 percent versus 110 percent in yen and 41 percent in euros. Far from helping GM, the weak dollar has driven up gas prices, and by Wagoner's own admission has made it tougher for GM to move its larger cars off the lot. That Japanese cars are known for offering good mileage speaks to how it could better weather the weaker yen of recent years compared to GM's struggles with the even weaker dollar.

The fallacious assumption that manufacturers can gain an advantage from a weak currency is best explained by Dartmouth professor Douglas A. Irwin in his book, Free Trade Under Fire. Describing the manufacturing process of a U.S. carmaker, he noted that:

30 percent of the car's value is due to assembly in Korea, 17.5 percent due to components from Japan, 7.5 percent due to design from Germany, 4 percent due to parts from Taiwan and Singapore, 2.5 percent due to advertising and marketing services from Britain, and 1.5% due to date processing in Ireland. In the end, 37 percent of the production value of this American car comes from the United States.

Irwin's passage shows what is often missed by devaluation advocates. Imported inputs are a big factor in the production of any exportable item, and as long as they are, the country that chooses to debase its currency will gain no advantage. If a cheap currency were the path to prosperity, Turkey, Brazil, and Argentina would be world economic powers, while the U.S., England, and Japan would be basket cases. The opposite is true.

Since 1971, the yen has risen 207 percent against the dollar. Despite this massive upward revaluation, the market-share of U.S. carmakers has continued to erode, with Toyota on the verge of supplanting GM as the world's largest automaker. That the yen has risen so substantially begs the question of how much stronger it need be for Detroit to be satisfied, or better, for it to realize that no competitive advantage can be gained from currency machinations.