Japan's Battle of the Buck

SINCE the mid-1980s, the US dollar's decline against the Japanese yen has been slowed somewhat through the intervention of the Bank of Japan in world currency markets, but the inexorable downtrend has continued.

With the yen now standing near the magic 100 yen-per-dollar level, yet another record high against the dollar in the postwar period, Ministry of Finance and Bank of Japan (BOJ) officials reportedly are planning to meet next month to discuss long-term strategy regarding the dollar.

With its vast reserves and its record current-account surplus, Japan has the financial resources to continue supporting the dollar. But its top money strategists question whether intervention makes short- or long-term sense. Sources in New York estimate that the BOJ is spending $2 billion a day to support the dollar and will be forced to continue to do so unless the market becomes convinced that a policy change is in the offing - either in Tokyo, Washington, or both.

With a gross daily turnover of at least $1 trillion, however, the electronically connected world financial markets have vast power to move the prices of currencies and other assets very quickly. The idea that central banks and their limited reserves can affect the ultimate direction of financial markets by spending a few billion dollars a week or even daily is absurd on its face. The task is made more complex by money managers' decisions, which frequently are made based on perception of anticipated futur e policy moves rather than such factors as real interest rates, trade figures, or economic activity. When the politically unimpressive Clinton administration welcomes a weaker dollar and a stronger yen, the markets take the United States authorities at their word and pound the greenback in cross-trades with the yen.

Despite recent intervention in the currency markets by the Federal Reserve, the BOJ has carried the vast burden of supporting the dollar over the past 12 months. Yet from the BOJ's perspective, defending the dollar alone is doubly futile in the face of widespread speculation in currency markets and Washington's pursuit of an avowed policy of competitive devaluation to boost US exports.

Estimates of how much the BOJ has spent so far this year to support the dollar vary. The consensus view is in the range of $20 billion, give or take a few billion. By purchasing dollars, the BOJ is, in effect, giving back in the form of intervention part of its $130 billion global current-account surplus. These purchases, however, only partly offset selling by Japanese companies and private investors, who continue to liquidate dollar investments and real estate in order to pay domestic yen obligations.

Many market observers warn of further dollar declines due to speculative selling and a continued slump in the Japanese economy, which is likely to result in further liquidation of dollar assets by Japanese firms. Indeed, recently the BOJ apparently bought billions of dollars in a massive but futile effort to prevent a further rise in the yen. For the week ended Aug. 11, the Federal Reserve reports a $9.6 billion increase in Treasury debt held on behalf of foreign central banks. The presumption in the mar ket is that the large change in this key weekly indicator resulted from BOJ dollar-support efforts.

Market sources say that Japanese banks, investors, and exporters inevitably will compel the BOJ to join the other Group of Seven nations - Britain, Canada, France, Germany, Italy, and the US - in embracing monetary ease and global "reflation." By sometime next year, they say, Japan will shift to easy money at home and allow the yen to decline against the dollar, perhaps to the 110-120 level.

Indeed, many market participants say the next move must come from Japan in the form of lower interest rates. For Japan as global producer, the deflation in its economy continues. There are rumors of large companies facing severe difficulties, but most of the companies and banks are quietly working out the mess left from the 1989-1991 "bubble economy." BOJ Governor Yasushi Mieno, for his part, continues to warn in comments to the financial press that the worst may not yet be over in the business sector. B ut the weak dollar eases the burden of many heavily-indebted corporations and reduces the cost of exporters' imported raw materials and other inputs. In fact, despite complaints about how much a weaker dollar actually "hurts" Japan, Japanese firms are rapidly diversifying production by investing billions of dollars in lower-cost Asian nations and even Mexico, which helps blunt the negative impact of a cheaper dollar.

Japan as global investor is more vulnerable. Although a lower dollar helps contain production costs, the Japanese business community's success in withstanding and recovering from the current severe asset-price deflation depends on the BOJ limiting the dollar's decline against the yen. A cheaper dollar shrinks corporate earnings abroad, depresses the value of overseas assets, and erodes the yen valuations of offshore investments.

Nevertheless, according to Washington's conventional wisdom, the balance eventually will swing in favor of a cheaper yen. Japan inevitably will be forced to follow the lead of the rest of the G-7, especially the US and Germany, and recognize that the deflation of the past three years is slowly giving way to the likely coordinated reflation of the mid-1990s. In order to revive economic growth, Germany's Bundesbank and, eventually, the BOJ, will be forced to resort to cheapen their money in order to defend

against competitive American devaluation and inflation.

The US's evolving but little-understood dependency on Japan's support in world currency markets illustrates the continuing long-term decline of American influence in the changing world economy. The dollar, though still the leading currency in world commerce and investment, is slowly losing place to other key currencies that are more astutely and responsibly managed at home.

As investment in Asia surges behind the twin engines of Japanese capital and cheap labor and raw materials, North America is weighed down by debt and a depreciating currency. It seems safe to predict a somewhat weaker yen in the near-term; but the longer-term outlook is for the German mark and the Japanese yen to retain their superior positions vis-a-vis the dollar - at least until Washington returns to a responsible fiscal policy.