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Monday, March 22, 2004
Japanese monetary authorities must take the risk of making sense
Japanese monetary authorities have been trying to keep the yen-dollar exchange rate above 105, and even to push it to 110. While their actions, of course, affect the sentiments of currency exchange dealers, we should realize that exchange rate fluctuations are determined not just by economic factors, but also political factors -- especially the risk of terrorism.
The euro-dollar exchange rate was at one time nearing 1.30 but has since dropped down to around 1.22, despite the absence of any appreciable change in economic fundamentals. Then came the railway bombings in Madrid.
The market has indicated that it smells some of that risk. We've noticed lately that more police officers are patrolling the streets in downtown Tokyo, and that the crackdown on illegally parked vehicles has apparently intensified.
The key factors affecting the international fund transfers that set these currency exchange rates, or people's decisions on where and in which currencies to keep their assets, can roughly be divided into two categories -- profitability and risk.
In a free-market economy, profitability is of course a crucial element when managing one's funds. But even if high yields are anticipated, funds will not flow into currencies or countries where the principal itself is at risk.
The recent movements in the yen-dollar rate in Tokyo are a typical example of where risk has taken center stage.
Japan posted a large trade surplus in January, and its gross domestic product in the October-December quarter expanded at a robust annualized rate of 7 percent. On the other hand, the current account deficit of the United States continues to expand. Economic fundamentals could not explain yen selling, but the yen did in fact fall against the dollar.
I heard one Japanese official involved in the intervention say, "If the yen rises, it will be more effective to leak information about terrorism."
I believe the official was joking, but the joke was too practical. Terrorism is linked to a broad range of issues, including the dispatch of the Self-Defense Forces to Iraq as well as the question of how Japan will protect the lives of its own people and their assets -- a matter that could entail amending the Constitution.
The credibility of media reports about possible terrorist attacks must be kept under close consideration, but another thing one must keep in mind is that once the currency market starts reacting to such information, it often becomes unstoppable.
Every time Japan intervenes in the market, monetary authorities trot out the explanation that the operation is not aimed at pushing the exchange rate to a certain level, but at preventing excessively rapid movements of the currency. If that's the case, then wasn't the recent depreciation of the yen too rapid? When the dollar dipped below 110 yen in early October, it took more than five months to hit 105 yen. But when the turnaround started in mid-February, it regained 5 yen in less than three weeks. Thus, if we are to believe the rhetoric of Japan's monetary authorities, the dollar's latest appreciation is undeniably fast and Japan should intervene to sell the dollar.
Also, Japan's reported plans to engage in intervention that will "push up" the dollar vis-a-vis the yen are undeniably intended to accelerate exchange-rate fluctuations to a certain level.
In these respects, the actions of Japan's monetary authorities do not match their words, and their officials owe the market an explanation.
Another source of risk is the huge reserve of U.S. dollars that has accumulated from these massive interventions. Japan's foreign-exchange reserves hit $776.8 billion at the end of February, and the risk from exchange-rate fluctuations has increased accordingly.
Japan is estimated to have $550 billion in U.S. Treasury bonds -- nearly half of all the U.S. government bonds owned by countries other than the United States. Federal Reserve Chairman Alan Greenspan is worried because movements in Japan's holdings of these bonds could trigger a rapid rise in interest rates. We need to take a hard look at the risk of accumulating excessive amounts of foreign currency reserves. Japan's monetary authorities also need to publicly explain how they plan to deal with the risk of concentrating so much of the country's wealth in the U.S. dollar.
Teruhiko Mano is a professor at Seigakuin University.