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Monday, Oct. 27, 2003

JAPANESE PERSPECTIVES

Road to stable exchange rates pocked with self-contradictions


The exchange rates for the yen, dollar and yuan were one of the major topics of debate during a recently held series of international conferences. And discussions on the matter are likely to drag on, given its leap from economics to politics as the United States prepares for the 2004 presidential election.

Here, I would like to summarize the arguments of the three countries -- the United States, China and Japan -- and highlight their self-contradictions.

First, the U.S. government, while claiming to support a strong-dollar policy, argues that foreign-exchange rates should be left entirely to market forces, and that exchange rate regimes that artificially manipulate currency values should therefore be corrected.

This is self-contradictory. There is no guarantee the dollar will remain strong when everything is left to the market. The United States has to accept a weakening dollar as the market's evaluation of that currency.

Furthermore, if Japan ends its intervention in currency markets -- a behavior Washington has criticized -- and if China changes its dollar-peg policy, which is likely to happen, appreciation of the yen and the yuan will run counter to the U.S. policy of maintaining a strong dollar.

Despite the official position, the United States, which is suffering from a huge current account deficit and is a net debtor because it accumulates such large deficits, is apparently hoping to steer its currency lower so it can boost exports and reduce imports, thereby creating jobs at home. At the same time, however, it wants to avoid a sharp depreciation in the dollar that could trigger an outflow of capital it has borrowed from overseas. We mustn't allow ourselves to be deceived by political lip service and fail to grasp Washington's true intentions.

Next up are China's self-contradictions.

Beijing says it is ready to accept appreciation of the yuan over the long term, but that it currently needs to stabilize the current exchange rate so it can maintain the export-led growth of its economy, which it argues is still in a developmental stage.

While China says it should still be considered a developing economy, it gave a stunning demonstration of its political and technological power by successfully launching its first manned spacecraft, the Shenzhou 5, just before the annual Asia-Pacific Economic Cooperation forum.

Exchange rates are supposed to reflect the relative power of the countries involved, and they should be determined by the markets, which isn't possible under China's currency regime. On the sidelines of the APEC summit, U.S. President George W. Bush and Chinese President Hu Jintao reportedly agreed to create a panel to examine the ramifications of letting the the yuan shift to a floating exchange rate system, but serious debate on the matter appears to effectively have been shelved.

The Chinese government seems to believe that lifting its dollar peg will lead its currency to appreciate. But who knows? True, China has accumulated huge amounts of foreign currency reserves, but it also has a large amount of external debt. If each of its 1.2 billion people were to keep $100, China's foreign exchange reserves would theoretically drop by $120 billion. There are reports that leads and lags are already taking place on the belief that the yuan could go either way.

Finally, the biggest self-contradiction for Japan is that the government, while advocating structural reforms and a domestic demand-led recovery, is in fact aiming for an export-led upturn by intervening in the currency market to keep the yen weak. Intervention to prevent yen appreciation is a policy sought by those who are against structural reforms. We must realize that a stronger yen will have the benefit of boosting consumer spending by raising the nation's purchasing power.

The Japanese government frequently explains that it is intervening in the market to stem excessively rapid movements in the exchange rate. But this is a lame excuse. The yen opened the year at around 110 to the dollar, hit nearly 135 by the middle of the year, and is now again being quoted around 110. Its movement so far this year shows a roughly symmetrical pattern. If the government is going to say it's intervening because the yen's appreciation is too rapid, why didn't it intervene when the yen was falling earlier this year?

As long as each of the players in this debate continues to present self-contradictory arguments to support its case, it will be difficult to reach a logical settlement that isn't temporary. History proves that stability in foreign exchange rates is a tall order unless each of the key economic players tries to correct its own weaknesses.

Teruhiko Mano is an adviser to Tokyo Research International Ltd.


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