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Monday, May 14, 2007

JAPANESE PERSPECTIVES

Security dogging weak yen, not strong dollar


The yen has fallen to above 120 yen against the dollar and as low as 163 yen against the euro. Although a weak yen and strong dollar are often confused as the same thing, what we're looking at today is a weak, yen not a strong dollar.

A currency exchange rate is a rate of conversion between two currencies. A comparison of two currencies alone will not easily show whether one is strong or the other weak, but a comparison with a third currency (like the gold standard under the postwar regime led by the International Monetary Fund) will make it easier to determine the positions of both.

The yen is currently declining against both the dollar and the euro, with the dollar declining against the euro, underlining the yen's weakness.

The soft yen can be attributed mainly to two factors.

The first is the three major currencies' interest rate gaps, which reflect differences in their economic fundamentals. A worldwide liquidity glut has de-emphasized the importance of the current account and increased the influence of capital movements on exchange rates. It is not just interest rate gaps that sway the currency market, but the forecasts of those rates as well.

Today, the yield on the 10-year U.S. Treasury bond stands at 4.6 percent, while the yields on government bonds in Europe and Japan are 4.2 percent and 1.6 percent, respectively. The exchange rates already reflect expectations for a future hike in EU interest rates, but rates in the U.S. and Japan are forecast to stay flat.

Needless to say, these interest rate gaps are encouraging the yen-carry trade, which has accelerated the drop in the yen.

The second factor is the "safety" of each currency. No matter how efficient an economy is, its currency will be less attractive if its nation's security is in doubt.

The yen's weakness — coming just as the nation is debating whether to revise its 60-year-old Constitution — appears to symbolize the link between exchange rates and national security.

Last month, two terrible incidents involving guns took place almost simultaneously in Japan and the United States — the fatal shooting of then Nagasaki Mayor Itcho Ito and the Virginia Tech massacre.

Violence is of course despicable and peace is important, but the two incidents show that peace cannot be achieved merely by wishing for it. The assassination of the mayor of a city devastated by the 1945 atomic bombings — which followed the attempted assassination of his predecessor 17 years ago — reminds us that both governments and individuals need to shield themselves from risk.

These two incidents negate a myth advocated by Socialists and so-called progressives in postwar Japan that the nation will never be attacked unless it attacks first.

Global security situations are rapidly changing and the types of risks are diversifying. North Korea has obtained missiles and nuclear weapons, and China has plans to introduce aircraft carriers while unilaterally developing oil fields in disputed areas of the East China Sea. The U.S., meanwhile, is preoccupied with Iraq and other Mideast issues, while its deterrence in regional conflicts precluding the use of nuclear weapons appears less solid than it used to be.

Enactment of a bill to lay down formal procedures for amending the Constitution — a piece of legislation now being discussed in the House of Councilors — is essential, if only to fill a gap in the legal system that has existed for decades even though the supreme code allows for revision.

The Democratic Party of Japan, perhaps as a strategy for the Upper House election in July, is distancing itself from the ruling bloc on this issue, emphasizing pension reform and the widening income gap instead. But it is the leader of the main opposition party, DPJ President Ichiro Ozawa, who has advocated that Japan become a "normal" country where national security is a priority of the legislature.

If Japan comes under missile attack, the income disparity and pension reform issues will drop off the political agenda. In the U.S., the Virginia Tech incident has triggered debate on allowing students to carry guns.

Of course risk environments differ from country to country, and the steps taken differ as well. But the days are long gone when Japan can afford to ask itself whether it should lock its own doors. The priority today should be to ask what kind of a lock it should use.

Teruhiko Mano is a professor at Seigakuin University Graduate School.


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