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Monday, Jan. 26, 2004
Japan's lone intervention effort reveals poor risk management
Just a few weeks after the new year began, the U.S. dollar dropped to the 105 yen range for the first time in three years and four months, and also hit a new low of $1.28 against the euro.
The primary factor behind its weakness is the threat of terrorism and the huge external and budgetary deficits of the U.S. economy. Although the administration of President George W. Bush publicly continues to advocate a strong dollar, it is widely believed in Japan and Europe that Bush, with an eye toward capturing votes from export-oriented domestic industries, is in fact condoning a weaker dollar.
It's worth noting here that there is a perception gap between Japan and Europe on the one hand, and the United States on the other, concerning the dollar's exchange rate.
The weighted average of the dollar's strength vis-a-vis the currencies of 26 countries with which the U.S. does a substantial amount of trade is released by the Federal Reserve Board. True, the dollar is roughly 10 percent lower than it was a year ago, compared with the currencies of the seven major industrialized economies, but it is about 10 percent higher via-a-vis the currencies of the other nations, and slightly higher overall compared with a year ago.
Washington may be worried that the dollar's weakness against the yen and euro could lead to a decline in the inflow of funds that are making up for its capital account deficit; but it may also think that, overall, the dollar remains strong. If so, emerging expectations that the Group of Seven economies may agree to conduct joint market intervention to stabilize the dollar as early as the beginning of February could prove false.
The major reasons behind the gap in the dollar's performance against the major industrialized economies and the developing economies are that China and some other Asian countries are keeping their currencies effectively pegged to the dollar, and that the currencies of Latin American nations like Brazil and Argentina are on the decline.
This is why there is strong sentiment in the U.S. for China -- now the biggest source of the American trade deficit -- to either let the yuan strengthen or tolerate a wider margin of fluctuation in the yuan-dollar rate.
China, for its part, appears to be contemplating pegging the yuan to a basket of currencies instead of to the dollar alone. But it will be some time before such a step is actually taken.
We must not forget that, among industrialized nations who allow free movement of capital, exchange rates are influenced more by capital movement than trade factors.
Jean-Claude Trichet, current president of the European Central Bank, has reportedly expressed concern about the dollar's weakness, but the ECB lacks established tools for supporting the dollar. This is because no rule has been set for deciding who will cover how much of the burden if the central bank suffers losses from the dollar's fluctuation.
Furthermore, the fiscal deficits of key European economies like France and Germany have ballooned beyond the allowable levels set under EU rules, and they are obviously not ready to accept any additional burden. The ECB's role will likely be limited to verbal intervention.
Under such conditions, Japan alone continues to intervene to support the dollar, but the government has come under criticism that its foreign currency reserves, which have nearly hit $800 billion, have generated an estimated exchange rate loss of about 8 trillion yen. History shows that a solitary effort by one country to defy the tide of the market will only produce a temporary effect.
In Japan, a weak dollar is often discussed in a negative light, but as a major importer of crude oil and foodstuffs, the nation stands to reap more benefits than disadvantages. Dollar depreciation will also boost the nation's external purchasing power, and should therefore be welcomed.
The recent outbreak of bovine spongiform encephalopathy, popularly known as mad cow disease, in the United States has reminded us of the need to diversify our trade structure. Heeding the proverb, "Don't put all your eggs in one basket," Japan should review its dollar-focused currency policy and adopt a more multifaceted view to spread currency risk.
Teruhiko Mano is an adviser to Tokyo Research International Ltd.