Japan's banks did not, as a rule, load up on toxic US mortgage debt. Yet the crisis affected the country deeply. For many years while leverage was easily available, the “carry trade” – borrowing in yen at its low rates to park cash elsewhere – kept Japan's currency cheap. Then, once the credit market turned, bringing the carry trade down with it, there was a prolonged period when the yen functioned solely as a perverse “safe haven”, gaining whenever volatility was rising, as measured by the Chicago Board Options Exchange's Vix index.
The carry trade appears to have been squeezed out of the system by about late November, when the yen and the Vix halted their joint ascent. When the yen peaked a few weeks ago, it had risen on a trade-weighted basis by 48 per cent in barely 18 months.
The yen has weakened in recent days even as volatility has risen, showing that economic fundamentals have at last taken over from the perverse correlations of the credit bubble. The problem now for Japan, and everyone else, is the health of those economic fundamentals. For Japanese trade, the financial crisis had two critical effects – it made its exports too expensive, thanks to the yen appreciation, and it slashed away global demand for those exports. As a result, the latest data show that Japan's exports have suffered a horrific decline. Japan exported less than half as much last month as it did last July, and no more than it typically exported in the mid-1990s.