The Yen: Now For The Hard Part

If Japan doesn't come through with real reform, the yen could still go through the floor

Is this the end of the yen's free fall? For months, U.S. Treasury Secretary Robert E. Rubin stood by as the Japanese currency sank to levels not seen since 1990. Traders figured he would never make a move and continued selling. Finance ministers around the world feared that the speculators were right--and braced for a new round of competitive devaluations and a deepening Asian recession. So when Rubin organized a massive intervention to save the yen on June 17, the markets took the initiative seriously. The yen quickly jumped 6% off its low of 146 to the dollar, set on June 15.

But will it stick? Not unless Rubin can somehow force Japan to fix its financial problems--a mess that has defied all solution for a decade. In return for a U.S. rescue of the yen, Rubin got reassurances from Japan's Ministry of Finance that Tokyo would let more banks fail, force full-disclosure of nonperforming loans, and bail out only the banks that seriously restructure. If they wanted to, the Japanese could move quickly to shut the weakest banks. Yet without true reform, the most that can be expected now, say experts, is that the yen will decline at a slower pace. And the specter of a yen collapse will continue to haunt the markets.

CHINESE ALARM. So what made Rubin finally act? With U.S. business leaders growing increasingly uneasy about the soaring dollar (p. 32) and Chinese leaders pressing for relief--to prevent a devaluation of the renminbi--Treasury officials began pondering an intervention over the weekend of June 13-14. After intense consultations with their Japanese counterparts over the next 72 hours, Rubin & Co. settled on a $2 billion government purchase of yen.

The biggest impetus was the mounting anxiety in Asia as the yen plummeted in the first two weeks of June. Especially alarmed were Chinese officials who feared their grand economic plans would be undone by a tumbling yen. The Chinese started lobbying the U.S. privately for an intervention in advance of Clinton's arrival in Beijing on June 25. "The Chinese have been complaining that we haven't been doing enough to stop the depreciation of the yen," which makes Chinese exports less competitive, says a top Administration official. Meanwhile, public statements showed Beijing preparing the way for their own devaluation. Chinese sources indicate that Beijing finance officials figured a yen weaker than 150 spelled disaster and would force a defensive action.

Echoing the Chinese were finance officials in Australia, Hong Kong, and Canada, who watched in horror as their currencies came under pressure too. Even the Deutschemark was feeling the pain, an ominous development since Europe needs stability to launch its single currency next year.

On the home front, chief executives from Motown to Silicon Valley have also been leaning on Rubin to curb the ascent of the dollar, which is curbing exports and eroding profits. "We would like to see a more activist role," said Caterpillar Inc. CEO Donald V. Fites, head of the Business Roundtable, one day before the U.S. intervention. So for the first time in Bill Clinton's Presidency, the U.S. Treasury engineered a joint intervention with Tokyo to bring down the dollar.

The next step is to push Japan for the reforms that could give the yen a solid foundation. Deputy Treasury Secretary Lawrence H. Summers and other global financial leaders were headed to Japan on June 18 to press for accelerated action. Says one Administration official: "We don't have the luxury of waiting. The Japanese need to take steps now to reinstill confidence." Clinton reinforced the point in a late-night phone call on June 16 to Japanese Prime Minister Ryutaro Hashimoto.

DIM PROSPECTS. These jawboning missions have produced limited results in the past. The Americans demand painful moves, such as shutting all of Japan's insolvent banks and clearing the market of bad loans. The Japanese always pledge action--then deliver packages of public-works spending, limited tax relief, and vague promises to do more.

Unless the pattern is broken this time, the world has to prepare for renewed weakness in the yen. Some analysts are still talking about a rate of 155 to the dollar. The drop to that level may be gradual, since traders may be more cautious in shorting the yen after the June 17 intervention. But Japan's dimming economic prospects still point to a weaker yen.

The Japanese themselves will keep putting downward pressure on their currency--mainly by selling it to buy investments abroad that will yield higher returns. In April, Japanese investors pumped a record $20 billion into high-yielding foreign investments, mostly bonds, according to the Ministry of Finance.

If the capital keeps flowing out, the Japanese stock market will continue to fall. A weaker Nikkei spells bad news for the banks, which count unrealized portfolio gains as capital. If their capital bases erode further, the banks will edge closer to insolvency and will pull back from lending even more than they have. All this means that Japan's credit crunch is likely to intensify, forcing more manufacturers to close, and sending the Nikkei into even lower realms. Foreign investors aren't likely to jump into a market where returns will be eroded by a declining currency.

PLUNGING CURRENCIES. If the weaker yen poses such perils to Japan itself, it's hard to figure why the Japanese have not acted to arrest the currency's slide. The explanation? It seems that officials at the Ministry of Finance had wanted a weaker yen to keep exports strong and provide some life to the economy as they tackled the bank mess. But they didn't anticipate the yen's dramatic fall, and they probably didn't want it.

Indeed, they're aware that a yen that falls too far is a mixed blessing. Toyota figures that every one-yen decline adds about $110 million to operating profits from exports to the West. But there's a cost: The falling yen sends other Asian currencies plunging and makes it impossible for consumers and businesses in those markets, among Japan's biggest, to afford Japanese goods. Besides, Japanese manufacturers have farmed out a lot of production overseas. "So even if we have a good exchange rate, it's not easy to increase exports," says Mitsubishi Motors. President Katsuhiko Kawasoe. Even now, Mitsubishi overseas plants are running way below capacity, and a shift back to the Japanese plants would be disastrous for them.

So responsibility for the ultimate solution to the yen/dollar crisis goes back to the Japanese and their leaders. The world is waiting for a sign that Japan is ready to tackle its problems, even at the cost of great pain to its conservative society. Instead, the world has gotten a temporary pause in the yen's decline, thanks to the world's central bankers. It's not enough.

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