Comments on Professor Ito's Paper

Hitoshi URABE (GLOCOM Platform)

The currency board system, when adopted in Argentina a decade ago, seemed like a perfect scheme. It had a phenomenal effect in stopping inflation which had been literally thousands of percent annually. Everyone in the international financial arena was pleased to see the results, commended the government's determination to implement such measures, and sat back and relaxed, until alarming indications began to come out ten years after the inception.

Professor Ito in his article effectively summarizes what went wrong with the currency board system, which worked so well in emergency did not function well in a relatively calm economy, where close watch and fine tuning are constantly necessary to guide the economy. The system's effectiveness was in fact a trade-off to giving up those fine tuning tools.

It used to be there was no such thing as a "sovereign risk". A naive perception prevailed which asks how could a country become bankrupt and be resolved with its people all living there. There had been no records of denials of debts to foreigners by any country even after revolutions or coup d'etat's, except when the Soviet government negated the debts, in the form of bonds, issued by the previous Tsar regime. The whole picture changed in early eighties, when the so-dubbed "accumulated debt crisis" spread across Latin America and much of the debt was "restructured", which is not a default technically but effectively re-borrowing at much lower costs and for longer terms than was originally agreed upon.

Through the restructuring exercise, the debts were sorted and classified according to types. Trade credits were at the top of the list to be serviced so that the country could keep importing food and essentials, as well as materials to keep the industry going. Next in line were debts in form of marketable securities. It was explained that as the securities may be held by innocent individuals, such as "widows and orphans", halting services to them would be un-humanitarian. At the end of the line were loans extended from commercial banks. The reasoning was that as banks being professional lenders, they should have provided credits based on their analysis of risk, well aware of the possibility that the borrower may go under. Loans from other countries and international financial institutions, such as World Bank, were treated individually, depending on the level of leniency of each lender.

Since then, many countries including those of Asia have gone through liquidity problems and a number of schemes were devised each time a crisis stroke on ad-hoc basis.

Professor Ito discloses in his article that IMF First Deputy Managing Director Anne Krueger expressed her "personal opinion" at a conference. Since then, her ideas, effectively a Chapter 11 for sovereign debts has been formalized at IMF, and is presently studied by the member countries. Recent reports revealed a discord between Ms Krueger and John Taylor, the U.S. Treasury Under Secretary, but as many supports the basic idea, it is quite possible that real discussions begin in the near future.

Professor Ito strikes the vital point in stressing the importance that "Japan as the world's largest creditor nation with huge amounts of private and public credit to various nations should actively participate in discussions on reform of the international currency system." Japanese delegation should be well aware that they will be negotiating to protect the property of Japanese people, the utmost task for any government in international arena.

There is another aspect worth mentioning, which is stipulated in Professor Ito's article as the second point, though in a rather modest manner. Putting it bluntly, it is about time for Japanese investors to learn that there is a risk factor involved in any and every sort of investment. Reports such as some local governments and municipalities have had incurred unexpected loss due to their holdings of Argentine bonds do not attract sympathy. It only reveals ignorance and neglect on the part of investors and could even face criminal charges in developed societies unless proven to have taken necessary and precautious measures upon decision making.

With a bit of sarcasm, if Japanese investors begin to recognize risk factors, and further realize that the risks are often greater when invested across national borders, some of the funds invested abroad could be repatriated to Japan, possibly inducing much needed domestic investment. Wishful thinking? Sure, Japan needs every bit of that now.