(UNTITLED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00553R000100060004-9
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 11
• Document Creation Date: January 12, 2017
• Document Release Date: June 15, 2011
• Sequence Number: 4
• Publication Date: January 1, 1983
• Content Type: REPORT

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Japan:
The. Undervalued Yen
What Can Be Done
Confidentisral
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EA 83-10016
January 1983
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 Directorate of Confidential
Intelligence
Japan:
The Undervalued Yen
What Can Be Done
This paper was prepared by an independent
contractor under the auspices of the Offices of East
Asian Analysis and Global Issues. Comments and
queries are welcome and may be addressed to the
Chief, Japan Branch, Northeast Asia Division,
Intelligence Council.
Confidential
EA 83-10016
January 1983
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(:ontidential
Key Judgments
Information available
as of 31 December 1982
was used in this report.
Japan:
The Undervalued Yen-
What Can Be Done
During the past year or so, one of the major analytical questions underlying
US-Japan economic relations has been the perplexing weakness of the
Japanese yen relative to the US dollar. This paper is a summary of a study
of this question done under contract for the Directorate of Intelligence by a
leading authority on international finance and exchange rates.
The study draws several clear conclusions. It adds to the growing weight of
expert opinion that Tokyo has not purposely "rigged" the yen to increase
Japan's competitive edge in world markets. The author argues that Tokyo's
mix of fiscal and monetary policies, coupled with the impact of relaxed
controls on international financial transactions, produced a surge in capital
outflows that increased the supply of yen in foreign exchange markets. At
the same time, major international wealth managers were less attracted to
yen-denominated assets-because of high real US interest rates and a
general attraction to US securities as a safehaven. International circum-
stances, particularly the US economic environment, were reducing the
demand for yen while Japanese Government policies were increasing the
supply.
The study implies that Tokyo is faced with a dilemma. The Nakasone
administration is committed to the same mix of economic policies that
contributed to the weak yen in 1982. Fiscal policy will remain tight while
the Bank of Japan tries to maintain a relaxed monetary policy. Even
though interest rates will probably remain low, most forecasts suggest
private domestic investment will not be sufficient to sop up the large pool of
Japanese savings. This will continue to push capital out of Japan, keeping
downward pressure on the yen, as yen are converted to other currencies be-
fore being invested abroad.
The study suggests that Tokyo should reexamine its mix of economic
policies with an eye to absorbing internally some of Japan's excess savings.
One possibility would be to have the government pump up spending to spur
aggregate demand. Conventional economics suggest that this policy would
also stimulate imports and reduce exports because of higher domestic
demand, resulting in a diminished Japanese trade surplus and, by reducing
foreigners' needs for yen, cause a continuation of higher-than-desirable
iii Confidential
EA 83-10016
January 1983
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yen-dollar rates. The study argues that this does not have to be the case,
because an expansionist fiscal policy could also increase demand for yen in
Japan and reduce capital outflow. Indeed, in recent years, such financially
motivated foreign exchange transactions have swamped trade-motivated
transactions.
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Japan:
The Undervalued Yen-
What Can Be DoneF-
The Problem
A substantial appreciation of the yen is a prerequisite
to reducing the disruption in the US economy and the
political tensions caused by the imbalance in trade
with Japan. Unless appreciation occurs, trade re-
straints are likely to become more comprehensive and
more severe. The structure of the Japanese economy,
however, is such that the country has a powerful
tendency to run current account surpluses. From the
overall financial standpoint, Japan's present surpluses
are not troublesome. They are small in relation to the
aggregate surpluses industrial countries must main-
tain if the developing countries are to meet their
essential needs for development capital.
not need to cut the price of their goods if the demand
for their product is so great they have to limit the
quantity they sell.
The Bank of Japan did buy more than $1.5 billion to
slow appreciation of the yen in January 1981, but
since that time it appears to have sold $8.8 billion
(through September 1982) in a vain attempt to stop
yen depreciation. Since December 1981, intervention
to support the yen has been frequent and substantial.
The practice has not been used in an active effort to
push the rate up, but only. to slow or stop a further
weakening. In central bank parlance, Tokyo was
"leaning against the wind."
Nonetheless, the Japanese payments position causes
grave concern to the United States and other industri-
al countries. Japan's competitive strength has enabled
it to increase its share in industrial-country markets
for automobiles, steel, and certain other manufac-
tured goods almost as rapidly as it expanded produc-
tion. The United States and Western Europe are not
able to adjust the structure of production in their own
economies quickly enough to avoid an extended period
of loss of output and employment in the affected
industries. Moreover, since mid-1981 the yen has
depreciated while Japan has maintained its current
account surplus. As a result, Japanese exporters are in
a stronger competitive position.
Tokyo's Policy
The yen's weakness is not the result of deliberate
Japanese policy. The charge that Japan is aggressively
promoting undervaluation of the yen in order to
maintain its large trade surplus with the United
States is not well founded. The fact that the American
automobile industry is demanding extension of the
voluntary restraints on automobile shipments proves
that the Japanese do not need a 265-yen exchange
rate to be competitive in the US automobile market.
The American industry complained loud enough to
cause the Japanese to accept voluntary limitations
when the yen rate was around 220. The Japanese do
At times, however, when substantial amounts had
been spent with little apparent effect, the Bank of
Japan appears to have withdrawn from the market
and let market pressures take over completely. At
other times, most recently in late October 1982, the
governor of the Bank of Japan has expressed great
concern about the decline of the yen and has said the
Bank would continue to try to "shore up" the yen by
intervening in the currency market as well as by
preventing a widening of interest rate differentials.
These actions by the Bank of Japan lend credibility to
frequent statements by Japanese monetary authorities
that a stronger yen would be in Japan's national
interest.
Some have asserted that Japanese monetary policy
was being kept easy to promote yen depreciation.
There has been an acceleration of the growth of the
domestic money supply in 1982. Defined broadly, the
money supply was rising 10 percent per year (season-
ally adjusted) in the April-June period, almost twice
the rate of increase of the previous three months.
Narrowly defined, money was growing at an even
faster rate. Consumer prices were unchanged or de-
clining slightly during this period so that rates of
growth of money in real terms were as large or larger.
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The Bank of Japan had announced a monetary annual
growth target of 11 percent for the first quarter of
1982, consistent with expectations of 5.1-percent real
growth and a 3.5-percent inflation rate. When growth
prospects dimmed and prices leveled out, the Bank of
Japan lowered the targets for the third quarter to
9 percent annually. Although these targets may not
suggest a restrictive monetary stance, the posture
cannot be characterized as one of unwarranted ease,
given the condition of the domestic economy. The
monetary stance may have contributed to yen weak-
ness, but it appears to have been determined by the
state of the domestic economy, not the desire to
promote exports.
Japan's record of modifying controls over capital
movements has also been cited as evidence of a
longstanding Japanese policy of promoting undervalu-
ation of the yen. The Japanese Government did
"change the rules" on the capital movements a num-
ber of times during the 1970s to influence the ex-
change rate. In every case, however, the Japanese
attempted to stop an exchange rate trend that had
already produced a major rate change, and they acted
to counter depreciation as well as appreciation. As
with intervention, their actions were always "leaning
against the wind," not aggressive manipulation. In the
mid-to-late 1970s when Tokyo liberalized capital
outflows to counter yen appreciation, they were acting
with the full support of US authorities who were
pressing for greater access to the Japanese capital
market. Moreover, their current reluctance to return
to capital controls to strengthen the yen is attributable
in part to strong US pressure to open their capital
market even further.
The Causes
The basic reasons the yen depreciated in 1982 can be
summarized as follows:
? The nearly complete removal of comprehensive gov-
ernment controls over capital movements and the
growing belief that they will not be reimposed,
which have encouraged Japanese investors to build
foreign portfolios.
? The existence of an interest rate differential be-
tween dollar- and yen-dominated assets that has
Confidential
been extraordinarily large for most of the year and
remains substantial.
? Sluggish economic growth and lack of business
confidence that announced government policies
would stimulate revival, combined with expectations
that the United States will soon resume moderate
growth.
Deteriorating prospects for the Japanese domestic
economy probably have played a much greater role
than is usually assumed. Between 1981 and the first
half of 1982 there was a swing of $5.5 billion (annual
rate) in foreign purchases on the Japanese stock-
market-from an inflow of $3.6 billion to a net sale of
$1.9 billion. Moreover, the decline in demand for
investment funds within Japan has stimulated an
outflow of Japanese capital that may be continuing
even with the substantial reduction in interest rate
differentials that has occurred in recent months.
Over the past decade the integration of financial
markets throughout the world has increased to such
an extent that trade in financial assets has come to
dwarf the volume of trade in goods and services and,
thus, to exert greater influence on the foreign ex-
change markets. The movement of exchange rates of
major countries is now much more heavily influenced
by the factors that affect the prices of financial assets
than by those that influence the relative prices of
merchandise.
There are no comprehensive data on the turnover in
the combined foreign exchange markets of the world.
US Treasury Under Secretary Beryl Sprinkel recently
estimated the total to be more than $100 billion per
day-$25 trillion per year: The International Mone-
tary Fund has forecast total world trade in 1982 at
$2.5 trillion.
The shift in the relative weights of capital movements
and trade as a determinant of the exchange rate of the
yen has been magnified by the fact that capital flows
in and out of Japan, which were under strict govern-
mental control in the early 1970s, have now been
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uontidential
largely freed from formal governmental controls. In-
complete as they are, the data are impressive. In 1969
long-term capital transactions between Japanese resi-
dents and foreigners were less than $7 billion gross
(net was $155 million). In 1981 the gross was $135
billion (net $6.5 billion). Gross volume of repurchase
agreements was about $50 billion in 1981; these
agreements were not permitted at all in 1969. The
increase in the short-term assets of Japanese commer-
cial banks during 1969 was less than $1.5 billion; in
1981 the increase was in excess of $38 billion. Obvi-
ously the sum of the individual short-term transac-
tions was many times that amount. During the same
period the sum of imports and exports of goods grew
from $27 billion to $280 billion.
Capital Controls
The exchange rate probably could be significantly
strengthened if the Japanese Government were to
reimpose sharp limitations on Japanese loans to for-
eigners. Japanese sales of samurai bonds in 1981 were
$2.6 billion; yen loans to foreigners were nearly $8
billion. If the new bond issues and new commitments
of yen loans were prohibited, a significantly higher
yen exchange rate might be needed to clear the
exchange markets.
Going back to rigid capital controls is not a step the
Japanese authorities would take lightly. US authori-
ties have been almost as insistent on the opening of
the Japanese capital market as on the opening of
Japan's goods market. Under Secretary Sprinkel has
assured Congress that the United States "will contin-
ue to encourage Japan to pursue the path of freer
markets, both in the trade area and in the financial
area."
Although they may not acknowledge it publicly, many
Japanese officials would probably admit privately that
the limits on the purposes for which Japanese banks
could extend foreign loans and the formal quantitative
ceilings on loans and samurai bonds were removed to
accommodate pressure from US officials. Knowing
that any increase in the opportunities to take advan-
tage of existing financial incentives for capital outflow
tends to cause further depreciation of the yen, the
Japanese were baffled by the US request. Although
the request was consistent with the basic American
principle of free market trade, the Japanese cannot
understand why it was pushed so vigorously when the
immediate practical impact would be to weaken the
exchange rate, worsen the bilateral trade imbalance,
and aggravate the political tensions.
In any event, the Japanese have now publicly an-
nounced the liberalization measures. In his announce-
ment prior to the summit in mid-1982 of actions to
open up the Japanese goods market, then Prime
Minister Suzuki included the statement that Japan
would "pay due consideration to further facilitating
foreign borrowers financing in the Japanese financial
market." Unless the United States reversed its posi-
tion, the Japanese would find it extremely embarrass-
ing to reverse their position on the capital controls at
this time.
As a long-run principle, the Japanese authorities
agree with Under Secretary Sprinkel. The Japanese
economy is the second largest in the non-Communist
world. Its long-term growth rate is higher than that of
other industrial countries and its domestic savings
rate is still the highest. It makes no sense for the
Japanese to be using variable quantitative ceilings on
capital outflow as a standard tool for influencing the
exchange rate.
Although the capital market in Japan may not be
highly developed compared with those of the United
States and the United Kingdom, it is large compared
with the markets of other nations. The domestic
market is also large in relation to the volume of
international movements, even at current rates. It is
logical that the Japanese capital market be accessible
to borrowers in other parts of the globe. International
use of the Japanese capital market cannot fully
develop, however, if the government continues the on-
again, off-again approach to foreign access that has
characterized the past decade.
Both the securities dealers and the large banks in
Japan have publicly argued against any return to
exchange control restrictions. They want to develop
long-term, continuing relationships with foreign bor-
rowers. Borrowers also want a reliable source of
funds. The tap has been opened and shut so frequently
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over the past few years that another shutdown would
seriously damage the credibility of the market and
make it difficult to rebuild.
Moreover, if US interest rates were to decline enough
to wipe out the differential between the rates in the
two countries, the pressure for movement of funds
from yen to dollars could be expected to decline quite
naturally. The Japanese would not want to gear up for
a costly return to controls only to have the need for
such action erased by a fall in US interest rates, as
has been predicted.
Finally, the continuing rapid evolution of the institu-
tional banking and financial system throughout the
world is making it increasingly difficult to prevent
capital movements when the financial incentives are
large. Foreigners who have invested in Japan cannot
really be prevented from withdrawing money they
have brought in-not if a country wants to attract
new foreign capital at some future date. Yet as the
gross volume of foreign capital invested in Japan
grows, the potential for sudden withdrawal also
grows. Much of Japan's problem today is just that-
foreign investors are withdrawing money.
Government controls could be used to block the major
channels for outflow of domestic capital and to impose
significant costs on other techniques for Japanese
investment abroad. The greater the volume and vari-
ety of transactions, however, the easier it is for
investors to evade government restrictions. Although
the Japanese have a reputation as a disciplined people,
leakages could be expected to be sufficient to affect
the exchange rate. It would, therefore, be necessary to
impose severe restrictions on virtually all types of
capital flows.
In other words, it is not practical for the Japanese
authorities to return to exchange controls short of a
grave emergency. The question then is does the
present situation constitute such an emergency? Im-
posing exchange controls may be the only feasible
method through which an adequate degree of appreci-
ation could be produced in short enough time to ward
off the application of quantitative restrictions. The
temptation to resort to trade restrictions to preserve
jobs in stagnant economies is becoming increasingly
irresistible the longer stagnation and high unemploy-
ment continue. The additional surge of imports of
Japanese goods, which must be anticipated in the
light of the exchange rates of the past six *months,
together with weakening domestic demand in Japan,
is likely to prove too much for either US or European
governments to accept.
If Japan attempted to curb capital outflows by bring-
ing contractionary pressure on the economy to drive
interest rates up, the domestic economic impact could
be far reaching. Weaker growth prospects and a
downward trend in the Japanese stock market could
induce further withdrawals of foreign funds. Deterio-
ration of economic prospects in Japan would tend to
divert domestic production to export markets leading
to even greater penetration of US and European
markets.
In theory, Japan-by increasing the fiscal deficit-
might be able to achieve higher interest rates without
an overall contractionary effect. The new political
leadership may make it possible for the Japanese to
continue with a large fiscal deficit, but probably only
for the purpose of injecting new domestic stimulus.
Although the application of fiscal stimulus to the
Japanese domestic economy would bring conflicting
pressures on the exchange rate, it seems likely that
reduced incentives for capital outflow would prove to
be the dominant effect. Combined with a modest
change in market psychology, such a reduction could
have a significant effect on the exchange rate. Thus,
domestic stimulus might be both in Japan's direct
domestic interest and in its broader interests
internationally.
Domestic growth might be the principal contribution
Japan could make to easing the economic and political
concerns of the United States and Western Europe in
the short-to-medium term and minimizing the retreat
into protectionism. The prospect of improvement in
domestic economic conditions and a higher growth
rate than has prevailed over the past year-even if not
high by postwar standards in Japan-would alter
investment psychology, reduce the net capital outflow,
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and strengthen the exchange rate. If at the same time
US interest rates should decline further, the US
economy revive, and fears about the stability of the
international banking system simmer down, the yen
rate should return to a level more in keeping with
purchasing power parities.
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