Punishing Effects of a Strong Yen Are a Problem ‘Made in Japan’

Over the past year, the fall of the dollar to a succession of postwar lows against the Japanese yen has raised concerns in some circles that the decline was somehow a reflection of problems in the U.S. economy. So President Clinton began talking up the dollar starting in June, 1994. Backing up the talk were massive foreign exchange interventions and numerous interest rate hikes by the Federal Reserve Board.

Yet the yen-dollar rate failed to respond.

The reason is that the current yen-dollar exchange rate is entirely “Made in Japan,� not in Washington. And, like so many things made in Japan these days, it is of high quality--and made to last.

In particular, the sellers of dollars in the foreign exchange market today are predominantly Japanese exporters who earned their dollars by exporting goods to the United States and other countries. Since they cannot pay their domestic employees or suppliers in dollars, they must sell their dollars and buy yen in the foreign exchange market.

Japanese importers, on the other hand, need dollars to pay for their purchases abroad. But the fact that Japan is running a $130-billion annual current account surplus means the exporters are selling $130 billion more in foreign currencies than the importers are buying.

The existence of this gap alone, however, is not a sufficient reason for the yen’s strength. If there were enough people in Japan (other than importers) who were willing to buy the dollars that exporters are selling, there would be no reason for the yen to go up.

There were just such eager buyers of dollars in Japan during the 1980s. Japanese institutional investors, such as pension and life insurance companies, were buying everything from Los Angeles office buildings to U.S. Treasury bonds. Since they could not buy the office buildings in the United States with yen, they had to sell their yen holdings and buy dollars. Because of their dollar purchases, the yen did not go up as much as suggested by Japan’s current account performance in the ‘80s. In retrospect, the investors were subsidizing the exporters by taking on their dollars.

In the ‘90s, however, these investors are all gone. They had to reverse course because they lost too much money abroad. Their ability to take risks also was impaired by the collapse of domestic asset prices at home. My estimate of foreign exchange losses suffered by Japanese investors since 1985 amounts to nearly 35 trillion yen, more than $350 billion. The losses these investors suffered from the collapse of domestic asset prices were even bigger. As a result, these investors today are neither able nor willing to take risks abroad. The departure of those who had filled the gap between Japanese exporters and importers means that the yen has no place to go but up.

The strong yen exacts a very unfair punishment. It hits Japan’s best industries--those manufacturers who worked the hardest and achieved the most--while leaving those protected by import barriers largely intact. Manufacturers move their production facilities abroad in desperation, but protected rice growers stay put, feeling no pain.

If this trend is allowed to continue, Japan will lose its best industries while keeping its least efficient industries. Such an outcome will end Japan’s reign as an economic powerhouse.

To reverse this unfortunate trend, the yen’s appreciation must be stopped. Since trade flows cannot be changed overnight, the fastest way to turn the exchange rate around is to have Japanese investors start buying dollars again. These investors are still flush with cash, so if they can be made to buy dollars, the yen’s appreciation can be stopped quickly.

The problem, however, is that these investors now realize what they were up against in the ‘80s--and why they lost $350 billion.

Investing abroad is equivalent to lending money to foreigners. And the Japanese did not lend that money to be charitable; the money they lent was their life insurance and retirement pension funds--in other words, money that had to be paid back at some point.

The only way for foreigners to pay back the money they borrowed from the Japanese was by increasing exports to Japan and thereby earning yen.

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Yet when Americans and others tried to pay back the debt by increasing exports to Japan, horrible things happened. The Japanese refused their products, saying the goods were of unacceptable quality, did not meet this standard or that regulation, etc. Some Japanese even told foreigners that they were lazy and weren’t working hard enough to penetrate the Japanese market, speaking as though it was strictly a foreigners’ problem.

It was the Japanese who lent the money to foreigners, and it was the same Japanese who refused to buy goods from those borrowers. Under such circumstances, foreigners could never pay back their debt. The result was a skyrocketing yen--and a $350-billion loss for Japanese investors.

The moral of the story is: If you are in a country with strong exporters but a largely closed domestic market, it is suicide to invest abroad because foreigners can never pay you back. In the ‘80s, nobody in the investment community--including me--realized what we were up against. After losing so much money, however, investors have become a little wiser.

To turn the yen around now, the Japanese government must persuade Japanese investors that this time, market opening is for real. That won’t be easy. With so many failed promises in the past and so much in foreign exchange losses still on their books, Japanese investors will not be easily persuaded--or easily fooled.

Japan might need to adopt import goals that are truly convincing. They are needed not to please Clinton, but to persuade Japanese investors that the government and industry are serious about market opening--and thus, that it is safe to buy dollars again.

There is nothing Clinton can or should do about the dollar’s apparent weakness against the yen. This is a problem only the Japanese can solve. They have to decide whether they want to keep their best industries or those protected by import barriers.

So far, Japan’s leaders have refused to make that decision, hoping that, somehow, they will be able to keep both. They don’t seem to realize that the subsidies provided by Japanese investors in the ‘80s are no longer available in the ‘90s.

Their continued refusal to make the decision, however, has resulted in the foreign exchange market making the decision for them. And the outcome so far has been most unfortunate for Japan.

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Headed Lower

The value of the U.S. dollar has been in a long-term decline against the Japanese yen. Yen per dollar, monthly closes except latest:

1995 Friday: 90.90

Source: Dow Jones & Co.

Koo Named to Times Board of Advisers

Richard C. Koo, senior economist at Nomura Research Institute in Tokyo, today joins the Times Board of Advisers.

Koo recently was ranked as Japan’s top economist by the Nikkei newspaper, that country’s leading business information provider.

He has served on advisory panels for the Japanese prime minister and minister of economic planning. Koo is an American citizen and holds degrees from UC Berkeley and Johns Hopkins University.