The current exchange rate problem did not arise from domestic factors in Japan — it was triggered by the ‘debt limit’ problem in US fiscal policy, which caused depreciation of the dollar. The Japanese government has reacted to the yen’s appreciation by intervening in the foreign exchange market; most feel that the effectiveness of this policy is limited, and that it is only a short-term solution. In the US, outstanding public debt is almost as large as its GDP, and more than half of that is owed to foreign investors. The US public debt has been the safest and most reliable asset in world capital markets, as it provides significant international liquidity. What the debt limit argument implies is that the ability of the US to supply further liquidity to world capital markets is at risk.
The stability of value and the ample supply of liquidity are prerequisites for becoming a key global currency. Ever since the US abandoned the gold standard in 1971, the dollar has continued to depreciate relative to other major currencies, including Germany’s former currency, the mark, and the yen. The stability of the dollar’s value was lost around 1998 when the US’s foreign assets became negative — and now the ample supply of liquidity also seems to have been lost. It is obvious that the dollar is beginning to lose its position as the key global currency. Japan has traditionally cooperated with the US to keep the dollar system. But now the Japanese government must recognise that the yen’s appreciation is not a transitory problem but an on-going trend, moving towards the collapse of the dollar system and the construction of an alternative currency system.
The strong yen is primarily due to the fact that Japan holds the most net foreign assets in the world. In addition, Japan has a huge amount of public debt outstanding, and is an alternative potential supplier of international liquidity, in place of the US, now that its fiscal sustainability is recovering. The appreciation of the yen may be the reaction of a market that demands the Japanese government provide international liquidity. Thus resolution of this fiscal problem is significant for the world economy as well as the Japanese economy. Japan, as a supplier of international liquidity, is in a good position to contribute to the stability of the world economy. But many in Japan, including policymakers, do not recognise this. The narrow-minded government is only engaging in policies that help troubled firms deal with possible recession; it is preparing to provide loan programs to medium and small firms. The government has no idea how to enhance the liquidity of the yen in the global economy — instead, it is preparing a policy that supplies liquidity in the form of dollars, not yen, to firms that buy foreign assets!
What the Japanese government should do is establish a scheme under which the economy can benefit from the yen’s appreciation, such as promoting the use of the yen in trade invoicing by Japanese firms, and establishing offshore markets for yen-dominated government bonds in foreign countries. More liquidity in yen in the world economy will provide large gains not only to the Japanese economy but also to the global economy, because the global currency system is stabilised when a strong currency becomes a key currency.
Dr Masaya Sakuragawa is Professor at the Department of Economics, Keio University.