What does the world want yen for? Japanese economic activity is crumbling, few foreigners are buying yen assets and plenty of locals are getting out of them. Research notes speculating that the yen will touch 160 to the US dollar are now common. Oddly, an almost fatalistic calm characterises that possibility. The reason is simple; should the yen break, all bets are off and the rest of whatever commentary you are reading can be discarded. Last week's revelation that the Bank of Japan (BOJ) spent US$18 billion trying to prop up the currency was a shock. Practically every hedge fund in the world is short the yen, yet Japan's mighty trade surplus remains. The implication is that, despite mighty intervention, money continues to exit the country. Since foreigners have not been big sellers of equity the outflow must be domestic, for want of a better word, flight capital. It is hard to imagine the dollar/yen rate could fall much below 135 to the dollar without triggering concerted central bank intervention. If it did, the message is that Japan will export its way out of trouble. More than that, it says Japan rejects the principles of markets driven by return on equity and that policy aims of capacity utilisation and full employment are unchanged. It says the last great fault line dividing the global economy in the aftermath of communism remains unresolved. Hope remains that the latest fiscal stimulus package will kick-start economic activity, engendering confidence in the financial system; in short - that investors are given something to believe in. Recent months have seen the BOJ dramatically expand its balance sheet, through advances to stricken financial institutions. This seems a desperate effort to prop up the system in the manner of the Bank of Thailand last summer. The contradiction is that foreign exchange reserves are being used to support the yen, while an almost deliberate policy of debasement is being pursued. Yet, in the absence of anything new, a population increasingly cognisant of its grossly under-funded pensions is likely to keep switching into US dollars or hard European currencies. The clever money wants to believe in the yen, because it knows the consequences otherwise. Any hint of dramatically improved economic performance or even of radical financial reform is likely to see the exchange rate snap back. The huge volume of shorts lined up against it should see to this. There are few positive indicators. A protracted yen weakening means a flood of cheap goods hitting European and the US. For Europe, on the brink of a fixed exchange-rate regime, this would mean deteriorating trade balances and higher interest rates. Companies there and in the US will face irresistible competition from Japanese exporters, hitting profits and so share prices. Embattled Asia will fair no better. Recovery depends on foreigners buying up banks and firms whose equity has been wiped out. Should governments allow their currencies to follow the yen, foreigners will walk away. Defending their currencies would mean even higher interest rates, which have stubbornly refused to come down despite much improved liquidity conditions. More than 50 per cent of the mainland's exports go to Asia. A spiral of decline would raise fears of a yuan devaluation and inevitable pressure on the Hong Kong dollar peg. Such a view assumes the Japanese economy is in as bad a shape as data suggest. It presumes the government is incapable of engineering a boost to domestic demand and that the US stands idly by. Perhaps the point is that US policy with Japan has shifted from demand for structural reform to pressure for reflation at any cost. So far, all efforts have failed, and attention must surely switch back to structural reform. The most effective would be to remove foreign-ownership restrictions on all Japanese banks. If the world's second largest economy is to remain in the fold, the world needs to be given a reason to buy yen.