In the karaoke bars in downtown Tokyo they must be belting out Shirley Bassey’s Hey, Big Spender. The Bank of Japan may lack the dash of the old hit’s hero, but it does know how to splash the cash.
Last year Japan’s central bank shelled out $187-billion propping up the sagging dollar. The pace is quickening. Earlier this month it spent $38-billion in one week alone.
This blunderbuss approach to foreign exchange market intervention is driven by fear. The authorities are worried that if the dollar falls too far against the yen, Japan’s exporters will become uncompetitive. They know they need the export motor firing on all cylinders if the Japanese economy is to drag itself clear of its decade-long recession.
The Bank of Japan may have to carry on popping its cork. As the new chief economist at the International Monetary Fund, Raghuram Rajan, noted rather carefully in a interview last week: ”There may have to be more exchange rate depreciation for the United States.”
Certainly the US has little incentive to reverse the dollar’s decline. This is presidential election year in the US, and President George W Bush is determined that his and his father’s administrations will not be remembered as the book-ends of recession bracketing Bill Clinton’s boom years.
As long as the currency depreciation does not spook the Federal Reserve into jacking up interest rates — and chairperson Alan Greenspan still sounds relaxed — a weaker dollar looks good for the US economy and Bush’s electoral prospects. US exports are already picking up, even though the trade balance is so deeply in the red it should probably be described as magenta.
Just to add a little icing to the cake, all those dollars that Japan is buying on the foreign exchange market are being spent on US government bonds — keeping US interest rates down and helping to finance Bush’s spending plans. The US’s Democrats could be forgiven for wondering if the Bank of Japan is staffed by Republicans.
For the Japanese, the US’s laissez-faire approach to the dollar must be worrying. Already there are those within the Japanese economic establishment who think the Bank of Japan’s policy of buying time for Japan’s exporters by buying dollars may have to be reconsidered later this year.
The Japanese are not the only ones facing dollar-induced problems. Eurozone politicians and economic policymakers have long sought to maintain their sangfroid in the face of a rapidly rising euro. Though they have so far refrained from chucking money at the foreign exchange market, they have recently taken to intervening verbally. European Central Bank governor Jean-Claude Trichet has led the jaw-jaw approach, commenting darkly earlier this month about ”brutal” currency movements.
So far the line that the pace of appreciation is of greater concern than the actual dollar-euro rate has had some impact. Trichet and friends knocked the euro back from a record of almost $1,29 to back below $1,25, but it has since recovered to more than $1,26.
But while central banks always worry more about ”disorderly” markets — rapid movements — businesses have to keep an eye on the actual level of the currency. As a junior German economics minister noted last week, an exchange rate of $1,25 is cause for concern, anything above $1,30 means real problems. France’s Trade Minister, Francois Loos, is already complaining that French firms are having to slash their margins to offset the impact of the greenback’s fall from grace.
The Japanese are hoping to have a word or two with the Americans at the meeting of the G7 in Florida next month. They will be looking, too, for support from the European members. ”It’s come to a point when Europe’s concerns … are the same as Japan’s worries about the impact on its economy,” according to the Ministry of Finance’s Hiroshi Watanabe.
The Europeans will certainly want to see exchange rates well up the agenda at the G7. Not only are they unhappy about the euro’s appreciation, they believe they are being asked to bear the brunt of the fallout from the tumbling dollar.
As German Deputy Finance Minister Caio Koch-Weser observed: ”Clearly the euro should not bear the burden of external imbalances, and the situation is a more complex one than in the 1980s because we have new players who increasingly play a role here — China and its links with east Asian economies.”
As long as China refuses to abandon the yuan’s peg against the greenback and allow it to appreciate, Japan has little choice but to keep the lid on the yen, leaving the euro badly exposed.
Koch-Weser’s fond remembrance of the 1980s, when the Plaza agreement in 1985 and the Louvre accord in 1987 marked the apogee of G7 efforts to steer the foreign exchange markets, should not stoke expectations of a repeat. In both instances the agreements were backed by significant moves in interest rates.
This time around there is less scope to back words with deeds. The Federal Reserve is hardly going to penalise US borrowers just to help out the Europeans and the Japanese; the Japanese themselves have little room left for manoeuvre. That leaves the Europeans. The European Central Bank, however, is in a bind. There is talk of a rate cut, though Nout Wellink, head of the Dutch central bank, said: ”The forces at work are much stronger and can’t be neutralised by a minor change in rates. This is not the instrument.”
Even if a cut in eurozone interest rates did have an impact on the foreign exchange market, would it be one the central bank wanted? Would cheaper borrowing depress the euro by cutting yields, or would it boost it because lower borrowing was seen as boosting economic growth?
So where does that leave the G7? The Americans will favour doing nothing, the Japanese are already doing all they can, while the eurozone has a problem whatever it does. Meanwhile, a key player, China, is not even a member.
The upshot is that whatever the G7 does will be wrong. So it should take the least damaging option and do nothing. That would disappoint the markets and depress the dollar. Better that, however, than raising expectations which cannot be fulfilled. — Â