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Monday, July 1, 2002

JAPANESE PERSPECTIVES

Dollar weighed down by external debts, tax cuts, skittish investors


The dollar is losing ground against major currencies and the foreign-exchange rates are reflecting the relative strengths of the economies involved.

The dollar's recent weakness appears to be mainly attributable to changes in the United States. The euro-yen exchange rate has so far been stabler than either the dollar-yen or dollar-euro rates.

There are three major reasons behind the dollar's recent weakness. The first is the rise in accumulated external debts. The U.S. current account deficit, which is equivalent to 4 percent of the nation's gross domestic product, is expected to expand.

In addition, as imports of daily goods no longer produced in the United States continue to grow, the worsening fiscal situation of the federal government is starting to manifest itself in the nation's external balance of payments situation.

The U.S. budget surplus in the latest fiscal year has been chopped down to nearly half the $36 billion posted in the previous year. And for fiscal 2002, the U.S. is forecast to post a budget deficit -- one in excess of $150 billion.

This is the result of the tax cuts introduced by the administration of President George W. Bush and the increase in military spending that followed Sept. 11.

Japan's monetary authorities have been intervening in the currency market to buy dollars to "adjust the speed of the yen's appreciation." However, past examples show that any market intervention that goes against the wind of the times, even if carried out in coordination with other industrialized nations, will be ineffective. At this time, intervention by Japan alone will only have a temporary, psychological impact on the market.

The presence of the euro as another key currency today is another major factor that cannot be ignored.

The second major reason for the dollar's weakness is the correction of the excessive rise in U.S. share prices.

The stock market remains in a slump even though the U.S. first-quarter GDP marked a faster-than-expected growth of 6.1 percent. The NASDAQ index has dipped below its post-Sept. 11 low and is now hovering in the 1,400-point range. Given the fact that the index topped 5,000 in early 2000, the situation can be described as the collapse of a bubble. And behind this market collapse are rising doubts about America's oft-praised concept of market-centered management.

One major characteristic of U.S. management style is that corporate executives emphasize share price as the top management goal because their bonuses are determined by that price. Of course, a higher share price is beneficial to shareholders, but when the initial benefits of the IT boom were exhausted, it became difficult for companies to keep boosting them the way they had before.

A company's share price naturally declines when its profitability falls. To avoid this, the U.S. management method dictates that shares should be bought back to adjust the supply-demand balance in the market. This certainly helps support the share prices, but it also hurts the company's future profitability because funds that should have been spent on improving productivity are instead tossed into the buy-back scheme.

If management borrows money to buy back the shares, it can pose a risk to the company's finances.

Share prices can also be maintained through mergers and acquisitions. The settlement of special costs incurred during M&As tends to be deferred because it reduces profits. But if the problem is left unattended for too long, it could easily develop into a worst-case scenario: management compiles a balance sheet that does not reflect the reality -- a scenario symbolized by the Enron and WorldCom debacles.

Multiple occurrences of that scenario have cast serious doubt on U.S.-style management, a method that was once touted by many.

Capital investment by U.S. firms in the January-March period fell 5.7 percent from the previous quarter. It is clear the sluggish investment resulted from reduced earnings caused by the above-mentioned factors.

The third major reason behind the dollar's weakness is that the asset effect -- which has so far supported the strong consumer spending -- is no longer there.

Besides the stock market slump, the increase in cash flow for consumers who benefited from loan-renewal schemes using the rise in housing prices and lower interest rates appears to have reached its limit. Share prices dropped even though consumer spending rose 3.5 percent in the first quarter, which suggests that market players sensed that the spending boom was losing steam.

Defying earlier expectations, the Federal Reserve Board is not likely to raise interest rates for the time being. Such a prospect could discourage the flow of funds to the U.S. from overseas savers.

In addition to the low interest rates and the risk of regional conflicts, the dollar's weakness is a key factor that has pushed up the price of gold, which is nearing $330 an ounce.

Teruhiko Mano is an adviser to Tokyo Research International Ltd.


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