Money Watchers Should Keep Eye on Japan's Exchange Intervention

RICHARD C. KOO is senior economist at Nomura Research Institute in Tokyo

There appears to be a large disparity between what is actually happening in Japan and how foreigners--particularly Americans--perceive these events. For example, many in the U.S. media and financial community believe that Japanese investors have been returning to the U.S. market since last summer and that their appetite for U.S. assets is a major reason why the American dollar and bond markets have rebounded.

The view that Japanese investors are back emerged when the Ministry of Finance announced in August a series of deregulation measures to encourage Japanese investors to invest abroad. Although none of the regulations that were relaxed are binding, many foreigners somehow rushed to the conclusion that Japanese investors are coming back to their markets.

In reality, as indicated by the Ministry of Finance's own statistics, Japanese investors have consistently been large sellers of U.S. securities since September. With cumulative net selling amounting to $16.8 billion from September to December, Japanese investors have been selling dollars--not buying them. Therefore, Japanese investors certainly have not been fueling any rebounds in U.S. financial markets.

In fact, the U.S. dollar has rebounded in large part because of massive foreign exchange intervention by Japanese monetary authorities to keep the yen weak. That's one reason why Japanese investors are selling dollars: They believe the yen's current weakness is both artificial and unsustainable.

For instance, in February alone, the Japanese government spent $20 billion to keep the Japanese yen weak. Although Japanese authorities insist that the aim of the interventions has been to "stabilize the exchange rate," the $20 billion that was spent--the largest monthly intervention in history--appears suspiciously close to "exchange rate manipulation." Indeed, the Japanese government has a long history of buying dollars to keep the yen weak in order to help exporters. Over the years, Japan's official holdings of dollars have ballooned to more than $200 billion.

In the United States and most other countries, when monetary authorities spend large sums of money to intervene in the foreign exchange market, they generally come under close public scrutiny for possible misuse of taxpayer money. After all, the public has the right to know whether the intervention is the best way to spend that money. Such scrutiny tends to get more intense if it turns out that the authorities actually lost money in their foreign exchange interventions. The fear of such scrutiny typically keeps governments from spending excessive amounts on foreign exchange interventions.

Japan is unique among countries, however, in that its monetary authorities face no such constraints. Already, the Japanese government has incurred losses well in excess of $90 billion through its intervention activities. In other words, the current value of the $200-billion-plus in dollar holdings is about $90 billion less than the cost. This $90-billion loss simply amounts to a subsidy to Japanese exporters by the Japanese government. But because the funding for intervention is totally outside the scrutiny of Japan's elected officials, hardly anyone has raised concerns about the losses.

The Japanese government's apparent willingness to use unlimited amounts of funds to push the yen lower, however, is particularly worrisome in a U.S. presidential election year. Pat Buchanan's strong showing in the early Republican primaries has put the spotlight on the economic unease of many middle-class Americans. In spite of rosy promises from mainstream politicians and economists about the benefits of free trade, the living standard of average American families has failed to improve for more than a decade.

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Although some of Buchanan's extreme proposals, such as imposing a surcharge on all imports from Japan, might not attract widespread support, his warnings about the plight of the average American family are prompting many others to look into the issue more seriously. In particular, they will want to know first whether foreign governments are really playing by the rules of free trade and not manipulating trade barriers and exchange rates in their favor.

After all, had the Bank of Japan not spent so much money keeping the yen weak over the years, the yen would have been much stronger against the dollar. That in turn would have improved the competitiveness of U.S. manufacturers and workers vis-a-vis the Japanese in all markets.

With more and more people questioning the very premise of free trade, monetary authorities in both countries should be sensitive to the potentially explosive political implications of excessive intervention in the foreign exchange market. The last thing monetary authorities should want in an election year is for the American public to feel that the exchange rate is rigged against them.

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