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Monday, May 8, 2000

G7 drop vital hints on future of fundamentals, forex market

Many observers have brushed aside the latest agreement made by the Group of Seven finance ministers and central bankers in Washington last month.

However, I believe upon careful scrutiny of the latest statement that one can find two changes which cannot be taken lightly.

First, regarding foreign exchange markets, the wording used to single-out the yen in past agreements — "We share concerns about the potential impact of the yen's appreciation," — has given way to the phrase "Exchange rates among key currencies should reflect fundamentals."

When discussing "fundamentals," more often than not the issue of economic growth rates comes to the fore. But as we see from the fact that the word is used in the plural, such components as inflation, joblessness and balance of payments must be taken into consideration as well.

It is true that the United States is experiencing an economic expansion that now spans more than 108 months, but we must not fail to note that its current account deficit is also swelling.

The latest statement again takes note of the fact that the U.S. needs to improve its savings rate as the flip side of the coin to running a current account deficit. We should also remember the fundamentals of the U.S. are not necessarily in good shape.

U.S. Treasury Secretary Lawrence Summers spoke at the Brookings Institution right after the G7 meeting and underscored the urgency of raising savings rates, while criticizing the 2001 budget proposed by the Republicans. This is because the U.S. personal savings rate as of February stood at 0.8 percent, the lowest level since the Great Depression of 1929.

In addition, the Department of the Treasury released in early April a "Savings Initiative" that lists such aims as improving the financial literacy of the American public and expanding tax-deductible savings options.

I would like to hope that the corrections made to stock prices recently, especially on the Nasdaq market, will prove to be good, if bitter, medicine. But it remains questionable whether the U.S. will be able to shake the "asset-effect syndrome" it has created over the past several years. When future movements of exchange rates come under consideration, the "multifaceted elements of fundamentals" will have to be closely examined.

Another reason the yen has been strengthening is the recent weakness of the euro. Should market intervention be necessary, it should be done vis-a-vis the euro rather than the dollar. This would help diversify foreign reserves and nudge U.S. savings higher.

Second, we should take a closer look at what the G7 had to say about Japan's monetary policy.

In the past, the phrase the G7 used said Japanese authorities "reiterated their intention, in the context of their zero interest rate policy, to provide ample liquidity."

In the April statement, the G7 used the exact same expression, which is simply a repeat of what the Bank of Japan's policy board agreed to do at a meeting before the G7 gathering. It did not include any future commitment.

Although consumer prices are stable, thanks in part to the strong yen, wholesale prices are rising due to such factors as climbing oil prices. Many firms are planning large-scale capital investments, especially in high technology.

Furthermore, there are indications the size of the call market is shrinking, something which is viewed as the downside of the zero-interest-rate policy. This is proof there is ample liquidity in the market.

We must also bear in mind that the zero-interest policy fuels feelings that income distribution is unequal, because interest income falls and puts the brakes on structural reforms.

In the first place, it is incongruous in this globalized world for Japan alone to continue its zero-interest policy at a time when both the U.S. and Europe are moving to raise their own key interest rates.

While Finance Minister Kiichi Miyazawa has recently backpedaled somewhat, due to the proximity of general elections, he has been passive in forming an auxiliary budget for the current fiscal year. A recovering economy and improved corporate earnings seem to have been behind his thoughts since the beginning of the new year.

If we comprehensively interpret all of these points, I feel we can nod in agreement with comments recently made by such figures as BOJ Gov. Masaru Hayami, who said conditions for dropping the zero-interest policy would soon fall into place, and new Japanese Bankers Association Chairman Yoshifumi Nishikawa, who said he personally feels the lifting of the policy is drawing near.

Teruhiko Mano is an adviser to BOT Research International Ltd.

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The Japan Times

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