An alternative viewpoint

THE gist of Fred Bergsten's argument is that the yen has fallen too far against the dollar, as a result of intervention by the Bank of Japan and jawboning by the Ministry of Finance. The result, he argues, is that Japan's trade surplus and America's deficit will widen and so reignite protectionist tensions. He urges the G7 to act swiftly to halt the yen's decline. Is he right?
     It is interesting to compare the current situation with that in early 1994, when America's then Treasury secretary, Lloyd Bentsen, was quick to call foul when the dollar rose above ¥112. This time round, Washington appears to have given its approval. Robert Rubin, the current Treasury secretary, said on October 29th that he had no problem with the dollar's recent rise.
     One big difference between now and then is that in 1993 the American economy had ample spare capacity. Now, however, after several years of robust growth, American industry is working flat out. With little slack in the economy, a cheap dollar would be more likely to boost inflation than exports. In these circumstances a stronger dollar helps to keep inflation in check and so reduces the need for higher interest rates.
     Indeed, the strength of the American economy relative to the still-fragile state of Japan's helps to explain the yen's fall. Mr Bergsten may be right, however, in suggesting that there is something "different" about the yen: the dollar has risen by 40% against the yen since April 1995; against the D-mark it has gained only 12%. Another reason for the weak yen is that Japan's monetary policy is extremely lax relative to America's--just as it needs to be to boost demand. Japan's interest rates are only 0.5% compared with around 5.5% in America. Indeed, it is the current strength of American's economy relative to that of Japan's that is sucking in more imports and causing America's trade deficit to swell this year.
     Mr Bergsten, in common with many other American economists, believes that a weaker dollar and a stronger yen would go a long way to reduce America's and Japan's trade imbalances. But dollar depreciation has been ineffective as a cure for America's external deficit over the past decade. The dollar fell from ¥270 in 1982 to ¥80 in April 1995; even at its current rate of ¥114 it is still cheap. Yet America's current-account deficit is expected to be $150 billion this year, not much below its peak in 1987.
     The reason why the cheap dollar has failed to reduce trade imbalances noticeably is that America's deficit and Japan's surplus basically reflect America's low level of savings and Japan's excess of savings over investment. And a change in the exchange rate cannot by itself correct national savings and investment imbalances.
     Indeed, attempts to manipulate exchange rates with the aim of reducing trade imbalances are likely to be offset by changes in prices. For instance, during the past decade of a strong yen, wholesale prices in Japan have fallen by 20%, while America's have risen by 25%. This has offset much of the yen's appreciation. Moreover, to prop up the yen, the Bank of Japan had to run an overly tight monetary policy which imposed severe deflation on the economy--the exact opposite of what it requires.
     Mr Bergsten wants the G7 to act to push the yen higher. In fact, the dollar may soon turn by itself. There is evidence that Japan's economy is starting to pick up at last--industrial production grew faster than expected in September, leaving it 3.4% up on a year ago--so at some stage over the next year its interest rates will rise.
     Another factor is that central banks rather than private investors have accounted for most of the increased demand for dollars this year. A study by Deutsche Morgan Grenfell, an investment bank, shows that the dollar's rise this year has been accompanied by a sharp increase in central banks' dollar reserves. The reserve figures, however, do not finger the Bank of Japan for pushing the dollar skyward of late. Japan's foreign-exchange reserves did increase sharply earlier this year, but in recent months they have barely budged. Instead, the increase in dollar reserves has been spread widely across central banks.
     The significance of these figures, however, is that if the dollar's strength is partly based on central-bank purchases, then it may not be sustained. At some point, the dollar may well slip back of its own accord.

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