Welcome to Japan, where this week's election for the leadership of Japan's ruling Democratic Party has been marked by the wailing of industrialists that the rising yen is pricing them out of world markets and destroying exports.

This has happened before in export-dependent Japan. What is new is that Japan's political classes have identified a new villain in the process.

China is now being blamed for the rise of the yen, just as it is blamed in the United States for the rise of the dollar, because of the way China uses the cash from its trade surplus to buy U.S. and Japanese bonds.

The more yen bonds that China buys, the more the yen rises on the currency markets and the more expensive Japan's exports become.

And in May, June and July of this year, China bought more than $25 billion worth of yen bonds. This is a record.

So in last week's debate between Japan's Prime Minister Naoto Kan and his challenger, the veteran political kingmaker Ichiro Ozawa, the challenger said he would intervene to force down the value of the yen. Kan said he had already made preparations to do so, consulting with other countries "so they won't say negative things when Japan acts."

The last time Japan intervened to force down the value of its currency was in 2004, when the yen stood at 109 to the dollar. Today, it is just less than 84 to the dollar, or about one-fifth more expensive in dollar terms than it was then.

Japan doesn't have a great deal of choice in the matter. For Japanese industrialists, the yen exchange rate is a matter of life and death. Toyota is the best-known example. Toyota's planners assumed an average exchange rate this year of 90 yen to the dollar. But for every one-yen increase in the dollar rate, Toyota loses $355 million in profit. So with the yen currently less than 84 to the dollar, Toyota is down more than $2 billion.

Toyota is unusually vulnerable because it still makes in Japan about half the cars it exports. Nissan and Honda lose less on the yen because they make more cars abroad. Nissan is down about $1 billion and Sony (which does a lot of manufacturing elsewhere in Asia) about $150 million.

The impact of China's purchases of yen bonds has become a hot political issue. Finance Minister Yoshihiko Noda last week told the financial affairs committee of the upper house of the Diet that Tokyo was watching the process closely.

"I don't know the true intention", he said, but was going to consult with Beijing to clarify China's plans.

Japan and China are each economies with a gross domestic product of around $5 trillion, so the $25 billion in Beijing's purchase of Japanese government bonds amounts to peanuts. Japan has more than $10 trillion in such bonds outstanding. But the impact through the exchange rate is far more dramatic, particularly if the markets suspect (as they do) that China plans a long-term trend of such bond purchases.

It is easy to accuse China of malign intentions, forcing up the currencies of trade rivals like the United States and Japan by buying their bonds so that China's exports remain cheap. But the real question is what is China supposed to do with its massive trade surpluses?

It could do what the United States did in its days as a trade surplus nation and build up its own version of Fort Knox and fill it with gold. (The effect of that was to keep the dollar artificially high and make the United States less competitive, which helped turn the country into a debtor nation.)

Or it could do what Japan did in its heyday as an export surplus nation and buy up lots of the world's most valuable real estate, like the Pebble Beach, Calif., golf course or New York's Rockefeller Center. Japan bought at the top of the market and took a bath when it had to sell as prices dived.

The point is that surpluses have to be recycled somehow. China accumulates dollars and euros and yen when it exports and is currently sitting on a nest egg of $2.5 trillion in foreign currency and securities. It has to invest that money somewhere, preferably abroad, because if it brought the money into China there would be a double effect, first raising the exchange rate value of China's own currency and secondly sparking a surge of domestic inflation.

China has experimented with buying foreign stocks and shares but got burned when the markets tanked. As a result, Beijing is a very conservative investor, buying government bonds and government-backed securities like Fannie Mae. And there have been times, when funding its chronic budget deficits, that the U.S. Treasury has been secretly relieved that China was such a reliable buyer.

But as China's doubts grow about the U.S. economic future, it is understandably diversifying into euros and yen and pounds. It is buying stockpiles of raw materials and investing in future energy supplies. This is very rational behavior, because at some point China's trade surpluses will shrink as its wages and costs rise and its citizens demand more French wine and Scotch whiskey, more Australian wool and Japanese design, more Chilean grapes and American airliners.

There is an alternative: that China faces the risk of volatile stock markets and uses its $2.5 trillion nest egg to buy up to 5 percent of every stock on the world's exchanges. According to the World Federation of Exchanges, the total global stock market capitalization in January this was just less than $50 trillion. Of this, $19 trillion came from the Americas, $14 trillion from the Asia-Pacific region and $13.5 trillion from Europe, the Middle East and Africa.

Had China made those buys in January 2009, it would have nearly doubled its money. Of course, had the Chinese bought six months earlier, they would have been sitting on a massive loss. Buying bonds seems safer, whatever the political price to be paid when Japanese elections hinge on the impact of China's bond purchases.

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