Japan's Battle of the Buck Nation's Central Bank Will Have to Cut Interest Rates to Halt Yen's Climb

Article excerpt

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 future 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 market is that the large change in this key weekly indicator resulted from BOJ dollar-support efforts. …