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Monday, Feb. 5, 2007

JAPANESE PERSPECTIVES

BOJ should have yen for watching stock economy, not just go with the flow


In its Policy Board meeting from Jan. 17 to 18, the Bank of Japan kept the key short-term interest rate unchanged at 0.25 percent on the grounds that prices and consumer spending were still weak. The decision triggered a yen selloff in the currency markets, pushing the yen down to around 122 against the dollar -- the lowest since March 2003.

However, it's not that foreign currencies are rising against the, yen but that the yen's value is declining. Not just against the major currencies, but against the won and yuan as well. Since the end of January 2006, the yen has declined 3.8 percent against the dollar, 10.6 percent against the euro, 7.2 percent against the yuan, and by more than 20 percent against the won.

While a weaker yen helps Japanese exporters, we must also recognize that it brings major disadvantages.

First of all, a weak yen effectively reduces the purchasing power of Japanese consumers. Major trade unions have launched their annual "spring offensive" wage negotiations, but they cannot possibly hope to win salary hikes well beyond the rate of inflation -- because raising their pay means hurting the international competitiveness of their employers in a globalizing economy.

Under those conditions, a drop in the yen's value against foreign currencies, reduces -- just as inflation does -- the effective purchasing power of consumers, thereby hampering government efforts to convert Japan from an export-driven economy to a domestic demand-driven one.

Second, the BOJ's ultra-easy monetary policy has effectively left interest rates on ordinary bank deposits in negative territory because they are being outpaced by increase in prices, thereby prompting more Japanese to move their savings out of the country.

Of the roughly 30 trillion yen in outstanding publicly offered investment trusts in Japan, 40 percent are managed in foreign currencies. Of those currencies, the U.S. dollar still accounts for about 40 percent, but other currencies are expanding their share as the fund management industry becomes increasingly diversified -- the euro now accounts for roughly 25 percent, the Australian dollar 11 percent, the British pound 6 percent and the Canadian dollar 5 percent.

But foreign currency-denominated fund management is not without risks, because the United States may, for example, shift policy and pursue a weaker dollar as a Democrat-controlled Congress gives greater consideration to U.S. manufacturers and labor unions.

In addition to the developments in domestic savings, the low interest rates in Japan have led to an increase in the "yen-carry" trade, where traders raise funds in yen at low cost and then manage the funds after converting them into other currencies over the short term. This kind of yen-selling has accelerated the decline in the currency.

The government, still saddled with a massive and growing public-sector debt, is opposed to an interest rate hike because it would increase its borrowing costs. Political pressure on the central bank will likely rise as the local elections in April and the Upper House election in July draw near. But lawmakers should not pass the costs of government debt on to consumers.

The third problem is that even though inflation remains low in terms of flow economy indicators, such as the consumer price index, there are some "bubble" elements emerging in the land and real estate trade.

The biggest factor that led to the asset-inflated bubble economy of the late 1980s was the judgment of the BOJ, which did not pay sufficient attention to price movements in the stock economy, and did not foresee the inflationary risk that would be raised by pouring excess liquidity into the land and securities trade.

This cannot be allowed to happen again. Some people point out that low interest rates and excess liquidity in Japan have contributed to instability in world commodity prices, including sharp ups and downs in crude oil prices. In addition to interest rates, the BOJ should take the liquidity factor into account.

It is globally acknowledged that the primary objective of the central bank's mission is to ensure price stability. This is because price stability -- even if it might cause a temporary slump -- will pave the way to sustainable growth.

As globalization progresses, the BOJ is responsible not only for pursuing domestic price stability, but ensuring stability in the yen's value against foreign currencies.

The central bank should take a global viewpoint and pay attention to price movements in the stock economy -- not just the flow economy -- when making its monetary policy decisions.

Teruhiko Mano is a professor at Seigaku in University Graduate School.


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