McKinnon: Dollar/yen
wars a lingering pox
on both countries’ houses
BY KATHLEEN O'TOOLE
The danger of a country
thinking its government can manipulate the real value of
money is showing up not just in Thailand and Malaysia. It
is also a chronic syndrome bedeviling America and Japan,
say a Japanese and an American economist in a new book.
America's insistence for
more than two decades that the value of the dollar be
lowered repeatedly in comparison to the yen in order to
alleviate the American trade deficit with Japan is
responsible for much of Japan's recent economic woes, and
the higher yen hasn't helped America either, according to
a new book by Ronald McKinnon, the Eberle Professor of
Economics at Stanford, and Kenichi Ohno, an economist at
Japan's Saitama University.
From August 1971 through
April 1995, the yen's value ratcheted up from 360 to the
dollar to 80 to the dollar. This was primarily because
some U.S. industries, anxious about their eroding share
of world markets, put political pressure on American
politicians. The American government in turn put pressure
on Japan's politicians and central banking officials to
keep raising the value of the yen against the dollar.
With some support from academic economists, American
producers argued that a higher-valued yen would help
their products sell better in competition with Japanese
products and therefore reduce the American trade deficit.
The great yen
appreciations, to which the Bank of Japan acquiesced,
temporarily ameliorated political tensions between the
two countries. But they imposed relative deflation on
Japan without correcting the trade imbalance between the
two countries, McKinnon and Ohno say in their new book Dollar
and Yen: Resolving Economic Conflict Between the United
States and Japan (MIT Press). The money meddling
eventually resulted in a severe economic downturn in
Japan from 1992 to 1995 what the Japanese call endaka-fukyo,
or high-yen-induced recession.
In early 1995, the U.S.
Treasury finally recognized that the Japanese financial
system was on the verge of collapse, the authors say. The
American and Japanese governments collaborated to drive
down the value of the yen on world markets, and the
Clinton administration quietly suspended some of its
complaints about Japanese trading practices. (Kodak's
complaints against Fuji, for example, were sent to the
World Trade Organization for resolution rather than the
government initiating unilateral sanctions against
Japanese importers.) Today, the yen, at about 120 to the
dollar, is near real purchasing parity with the dollar,
the economists say, but that doesn't mean that what they
call the "syndrome of the ever-higher yen" is
permanently over. The countries have apparently developed
a reputation with their own citizens for exchange rate
meddling so that even when they aren't trying to change
the dollar/yen rate, people expect a currency battle to
break out again.
Evidence that the problems
aren't going away easily comes from investors, McKinnon
says, who are willing to buy Japanese bonds that earn
substantially less interest than American bonds.
"Ten-year benchmark
Japanese government bonds (JGBs) now yield less than 2
percent, while 10-year U.S. Treasuries yield more than 6
percent," he said. The large spread suggests that
"on average, the markets expect the yen to drift
upward against the dollar at the rate of about 4 percent
per year over the next 10 years. Without this
expectation, investors would be unwilling to hold JGBs
instead of U.S. Treasuries."
The dramatic shift in
American policy in the spring of 1995 "allowed
modest recovery of the Japanese economy in 1996 and into
early 1997," he said. "But Japan's economy
seems to be weakening again in mid-1997. In the second
quarter of this year, Japan's domestic expenditures and
GNP fell sharply. Not surprisingly, imports declined and
exports increased because domestic demand was so
weak."
With Japan's trade balance
growing again, Americans could start hectoring the
Japanese to appreciate the yen. "This would cause
another major slump in Japan's financially weakened
economy, continuing the vicious circle," he said.
"Ohno and I claim
that the main factor weakening aggregate demand in Japan
at the present time is the threat that the yen
will again start rising against the dollar. The present
exchange rate of 120 yen to the dollar is more or less
right. We would estimate the purchasing power parity
exchange rate to be about 125 yen to the dollar.
Nevertheless, if people expect the yen to begin rising
again, this will deter current investment and
consumption. Investments in plant and equipment in Japan
now would seem unprofitable to operate in the future.
Similarly, Japanese consumers might wait for a better
deal before making big-ticket purchases."
The dilemma is how to
revive Japan's domestic demand for goods and services
without running large government deficits, he said.
"Huge but low-yield government investment programs
throughout most of the 1990s have already left Japan's
government with an enormous gross debt relative to its
GNP and relative to its aging population," he said.
The only way out, he and Ohno argue, is to remove the
threat that the yen is likely to rise into the indefinite
future so private investment and consumption will surge.
While they don't claim it
is simple, the two say the threat of the syndrome can be
unraveled if Japan and the United States can
"rationalize" their relationship in
complementary dimensions.
"First, Japan agrees
to complete the opening up and liberalization of its
domestic markets, including agriculture and construction,
while the Americans agree to cease all trade threats
in automobiles, computers, semiconductors and so on as
well as cease demands for yen appreciation,"
McKinnon said, summarizing the detailed analysis in the
book.
Second, he said, "we
recommend that the Bank of Japan and the U.S. Federal
Reserve system agree on a joint program designed to keep
the yen and dollar trading within 8 percent of their
current purchasing power parity of 120 to 125 yen to the
dollar. Although leaving rates flexible in the short run,
the expectation of continual yen appreciation would be
ended." SR
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