Japan's Role in International Currency Negotiation
Toyoo GYOHTEN (President, Institute of International Monetary Affairs)
(This article is based on an interview with Mr. Gyohten on February 4, 2004)
First I would like to express strong concern that disequilibria in the international balance of payments are gradually expanding on a global scale, mainly due to an increasing current account deficit in the U.S. balance of payments. Sooner or later we will not be able to let it continue deteriorating without limit.
Of course, this is not the first time such concern has been raised. In fact, since the 1960s the U.S. trade deficit and Japan's trade surplus have constantly been observed, and the global problem of disequilibrium in the international balance of payments has extensively been discussed among academics as well as economic analysts. Some have argued that the U.S. dollar could collapse any time and that international financial markets would become chaotic as a result. But that has never happened. Therefore, at least among Americans there seems to be virtually no sense of crisis about either an increasing U.S. deficit or a cheaper U.S. dollar.
In my opinion, however, the recent condition seems to suggest that we have entered a somewhat different stage. The first reason to support such a view is that the U.S. has clearly shown a consumption-led economic growth pattern. Especially since the late 1990s, the U.S. economy has become so dependent on household consumption and government spending that it cannot easily change course. In fact, the increase in the current account deficit quadrupled for the period of five years from 1997 to 2002, and that seems to be a break from the past.
The second reason is found in the U.S. industrial structure, in which the U.S. economy has been more and more service-oriented and less focused on manufacturing, especially producing consumption goods for households. Therefore, it has become less likely than before to replace imports with domestically produced goods even if import prices increase as the value of the dollar decreases. Also, the capacity of exporting manufactured goods from the U.S. has markedly been declining, and therefore the recent change in the U.S. industrial structure as a whole makes it difficult to reduce the trade deficit regardless of exchange rate adjustments.
Declining US Capital Flow
Furthermore, in the capital account there used to be a massive capital flow into the U.S. from overseas due to more vitality and high returns on investment in the U.S. compared to other economies. This took place in the form of M&A investment from Europe to the U.S., and in the form of direct as well as portfolio investments into U.S. stocks and government bonds from various countries including Japan. These days, however, a stable flow of capital into the U.S. seems to be shrinking, probably due to some concern about the sustainability of the fiscal deficit and also possible terrorism in the U.S. In addition, the Euro appears to be gradually increasing its presence as a substitute for the U.S. dollar.
Because of all these factors, the international financial markets have become much more unstable than before as there are now chronic tendencies towards a cheaper U.S. dollar and higher Euro and Yen in the markets. Something needs to be done, specifically the public intervention that Japan is conducting to support the dollar. But there is a question as to how much longer this can be maintained. If it stops the U.S. dollar is expected to decline sharply, at least temporarily.
If the yen increases sharply, Japan cannot leave it as temporary. Japan's industrial structure is oriented towards big manufacturing businesses and those business people would raise their voices to do something about the high yen. Moreover, such voices might well be amplified by the mass media, and would psychologically affect investment and consumption as well as stock prices negatively. Thus, Japan cannot help but continue intervening in the foreign exchange market. On the other hand, it must be felt by almost everyone that it has to be stopped sooner or later.
If the view that the problem of the U.S. balance of payments is entering a new, more serious, stage is correct, the market could give a warning leading to suspension of dollar investment or a shift from the dollar to the Euro, and the dollar might possibly collapse. Of course, no one wants to see this happen, but that would actually materialize if everyone rushes into selling the dollar quickly. At any rate, one can be sure that the situation has become less healthy and less stable than it was ten years ago.
New East Asian Currency Issues
In the meantime there are new issues regarding East Asian currencies including the Chinese yuan, an issue that was non-existent in the context of the currency problem in the past. Recently, however, East Asia has increased its presence in terms of currencies and now accounts for about half the U.S. trade deficit. Furthermore, its main currency, the Chinese yuan, is pegged to the U.S. dollar, and therefore Chinese exports to the U.S. would not decrease at all regardless of how low the dollar becomes. But no one can any longer ignore the issue of Chinese, Korean and Taiwanese currencies.
Thus, not only the G7 countries but also China and Korea should participate in an international currency negotiation, which is essential from Japan's standpoint, as such Asian countries and Japan now share the same fate. In this sense, Japan is heavily responsible as an intermediary to introduce China and Korea into an international currency negotiation. Unless Japan, along with other Asian countries, negotiates with the western countries skillfully, the U.S. and Europe might get together to criticize East Asia for its huge trade surplus and unilaterally demand currency revaluation or inflation policy of the East Asian countries, just as they jointly blamed Japan in the past.
Japan must work hard to help reach an international agreement for currency adjustments. Otherwise there will be an increasing degree of instability in the international monetary markets. If, however, Japan participates in an international negotiation, account should be taken of not only Japan's own position but also East Asia's response. In any case, no international negotiation can be conducted until the right moment. Currently there exists no sense of crisis on the part of the U.S., and therefore preparations should be done patiently in order to hold an international currency meeting in the future, perhaps five years from now.
International Currency Meeting Goals
What are the aims for such an international currency meeting? First, regarding exchange rates and regimes, pegging to the dollar or the yen must end and the flexible exchange rate system should generally be adopted without exception, while setting up a certain range in which exchange rates are allowed to fluctuate in order to avoid excessive movements in exchange rates. For example, the yen might be allowed to fluctuate within a range of 10% above or below 100 yen per dollar, and the U.S. and Japan would cooperate to intervene once the yen moves beyond that range. This would lead to stability and predictability in the foreign exchange markets, and facilitate trade and investment. The first aim is to determine such ranges for various currencies.
The second aim for the international currency meeting is to discuss what to do to keep the world economy growing without relying on the U.S. economy. Here the most important issue is to reduce the U.S. trade deficit and correspondingly reduce other countries' exports to the U.S. This means that export-driven economies such as Japan must change themselves and expand domestic demand. To reduce the wide imbalance on a global scale will yield a very large deflationary impact, and therefore it is necessary for trade surplus countries to reduce their surpluses by adopting strong anti-deflationary policies.
Japan needs to expand domestic demand above all. For that purpose there should be thorough deregulation to create an environment in which various business opportunities can be realized. That means that open and rational markets of the U.S. style must be applied to all fields in the Japanese economy. With deregulation there will be less difference between domestic and overseas prices. Such a difference has so far led to strong opposition to a higher yen, but without it more people will benefit from declining import prices due to a higher yen.
In sum, it is necessary to achieve these two aims at an international currency meeting: to establish a stable exchange rate system and to maintain world economic growth while reducing the U.S. trade deficit. It might well take more than five years of preparations to have a successful meeting, and Japan must start its effort for that purpose now.