THE POWER OF THE JAPANESE MONEY MACHINE
The nation's cash pump supports bond and equity markets worldwide. What if it stops?
If global investors needed a wake-up call about the power of Japanese money, they received a nasty one during the summer. During two weeks in July, the Dow Jones industrial average shed about 6% of its value, setting off tremors on bourses worldwide. At the time, market pros pinned the decline on disappointing corporate profits and fears of rising interest rates and a slowing U.S. economy. But 7,000 miles away in Tokyo lies another explanation.
Right around the time that Wall Street was beginning to falter, the Japanese central bank's purchases of U.S. Treasury bonds suddenly began a brief, and still unexplained, decline. As the yen rallied and long-term U.S. interest rates rose by 30 basis points, Wall Street's equity traders went into a funk. "The Bank of Japan was the culprit," contends Michael J. Howell, chief strategist at London's ING Baring Securities Ltd. "The sell-off had nothing to do with economics at all."
What it did have to do with was sheer financial clout. Even after a recession and a humbling domestic banking crisis, Japan's influence on world markets is formidable. Its accumulated wealth is still immense beyond anyone's wildest dreams. For years, the Japanese have been piling up dollars--the main product of their export winnings. Their current-account surpluses now total an incredible $1.2 trillion, and they must be recycled abroad to keep the yen from soaring so high it leaves the economy in ruins.
That nearly became the case in 1994, when the Japanese money pump slowed down. A meltdown in land and stock prices after the blowout of the 1980s "bubble" economy had left investors too stunned to send money abroad. Burdened with $800 billion in bad real estate loans, Japanese banks were unloading Manhattan skyscrapers and condos in Hawaii in a rush to repatriate their funds. This contraction in Japanese long-term capital outflows contributed to a spike in world interest rates and the biggest sell-off in the global bond market since the 1920s.
TENSE MOMENT. Early last year, events threatened to spiral out of control. With Japanese capital flows no longer propping up the dollar and with trade tensions mounting between Washington and Tokyo, the U.S. currency plunged to an all-time low of 79.75 yen in April. The drop pushed the Japanese economy close to a deflationary spiral, bringing the Bank of Japan, the Federal Reserve, and the German Bundesbank to the rescue. Central bankers ended the greenback's free fall by purchasing every dollar they could find on foreign exchange markets.
Since that tense moment, the Bank of Japan has slashed its discount rate to 0.5%, and a flood of Japanese money--some $130 billion, and perhaps far more--has poured into the world's capital markets in search of higher returns. As Japan has accumulated dollars and German marks in exchange for its Toyotas and Toshibas, its reserves of foreign exchange have ballooned (charts).
The International Monetary Fund estimates the Japanese government now owns $211 billion in foreign currencies, more than twice what Germany holds and by far the largest official stockpile anywhere on earth. Most of the sum is being held in dollars, reflecting the U.S. currency's liquidity and its prominent role in Japanese trade. And most of those dollars have gone into U.S. Treasuries. "Japanese money," admits Eisuke Sakakibara, director-general of the Ministry of Finance's international finance bureau, "has played a role in...propping up world equity and bond markets."
SUMMERTIME DIP. Other countries with big trade surpluses, including China and Taiwan, are also investing heavily in U.S. bonds. But Japan's purchases of Treasuries dwarf those of its wealthy Asian neighbors--and everybody else. Even allowing for the summertime buying dip, J.P. Morgan Securities Asia Ltd. economist Jesper Koll estimates the Japanese are still putting an estimated $3 billion a month into Treasury debt. The Bank of Japan is providing the biggest part of this cash. But a growing share is coming from individuals, while insurance companies and other big private investors are under pressure from the Ministry of Finance to join in the recycling effort.
As central bankers and finance ministers convene in Washington on Sept. 28 for the World Bank and IMF annual meetings, the burning question before them has to be whether the Japanese money pump will falter once again. Indeed, some economists are starting to grow concerned. Since peaking at $130 billion in 1994, Japan's current-account surplus has been heading steadily south in the face of a strong yen, a recovering economy, and pressure from Washington to boost imports. The nation's surplus includes balances for trade in goods and services as well as foreign aid payments. This year, Merrill Lynch & Co. estimates, the surplus will fall to $73 billion. By 1997, it could be down to around $52 billion. A few analysts--but not those employed by the Ministry of Finance--even see current-account deficits looming by 2005.
In addition to the declining surplus, many economists expect the Bank of Japan to raise interest rates next year if the slow recovery finally gains speed. The combination of higher rates and a more lively economy could leave Japan with fewer dollars to recycle abroad and send U.S. bond yields up by 25 to 50 basis points, economists believe.
With luck, however, that won't come to pass. Merrill Lynch economist John Praveen, for one, notes that Europe and other Asian economies, with hefty surpluses of their own, could fill any hole that Japan might leave. And even with declining export earnings, Japan will still need to recycle more than $120 billion in surpluses this year and next. The continuing surpluses virtually guarantee that the dollar will continue its long-term decline. But with President Bill Clinton and Japanese Prime Minister Ryutaro Hashimoto facing elections this fall, neither side wants to see market turmoil.
That means the Clinton Administration, which once found a handy trade weapon in talking the dollar lower, is more likely to continue its recent emphasis on stability. Japanese officials indicate they will also try to maintain the dollar's value around its current level of 110 yen by keeping interest rates low at home and money flowing abroad. Says Sakakibara of the MOF: "We both want a stable currency market."
Assumptions of a tacit deal to keep the yen's value within 10% of 100 to the dollar, plus moves by the MOF to ease Japanese investment abroad, helps explain the continuing rush of foreign borrowers into the London and Tokyo bond markets. Next month, the World Bank plans a $1 billion Eurobond offer in London aimed at Japanese investors. Others are tapping the Euroyen market, where Japanese buyers should easily absorb more than the $95 billion in bonds they bought in 1995. The action is no less frantic in Tokyo's Samurai market, where foreign companies sell yen debt. Some $26 billion in Samurai bonds have been issued this year, nearly twice 1995's pace. Walt Disney Co. alone issued $1.38 billion worth of Samurais this summer, in part to help pay down debt related to its acquistion of Capital Cities/ABC Inc. Most borrowers exchange their yen for dollars, keeping the recycling system going.
Japan's investment in factories overseas is also on a roll, totaling $14 billion in the first seven months of the year. Over the long haul, such direct investment may actually turn Japan into a less dominant player in global capital flows. From VCRs to autos, a growing volume of consumer and capital goods that were once shipped out of Japan are now being shipped in. Someday, Japan may even remake itself into a net importer by tapping its $9.7 trillion in household savings to boost its long-term growth rate.
GROWING OLD. But that is not the only force that will weigh on savings. By 2025, some 26% of Japanese will be senior citizens, up from 14% today. That large population of the elderly will force Japan to divert a greater portion of its economic output to social security and medical payments.
But slowing Japan's export colossus and draining its huge savings pool will still take years. In little more than a decade, Japan achieved something that has never occurred in modern economic history: a current-account surplus of more than $1 trillion. It will be recycling its capital--and keeping overseas markets aloft--for years to come.By Brian Bremner in Tokyo, with William Glasgall in New YorkReturn to top