(UNTITLED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000706760001-4
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 9
• Document Creation Date: January 12, 2017
• Document Release Date: March 21, 2011
• Sequence Number: 1
• Publication Date: October 27, 1986
• Content Type: MEMO

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Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
27 October 1986
Japanese Capital: Still Flowing Freely
to the United States
Summary
Japanese investment managers continue to channel long-term
funds into the United States, although reports indicate that high-yielding
Australian and Canadian bonds are attracting some attention. We believe
the availability of low risk financial instruments in the far larger and more
liquid US financial markets will continue to attract Japan's big institutional
investors, who are motivated by the need to recycle the proceeds from
Japan's massive current account surplus and by the opportunities
presented by Tokyo's ongoing deregulation of capital controls.
leading Japanese securities companies want to
make large-scale investments in order to convince the Federal Reserve
Board to grant them the status of primary dealers of US Government
bonds. Although this long-term perspective suggests Japanese funds will
continue to flow freely to the United States, developments such as higher
oil prices or increased domestic demand in Japan could sharply reduce
future investments.
This memorandum was prepared by , Office of East Asian Analysis.
Information available as of 27 October 1986 was used in its preparation. Comments and
queries are welcome and may be directed to the Chief, Japan, Northeast Asia, OEA, on
DATE
DOC NO C;ZI- Al- 96 01(oLf
OIR
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Large Capital Outflows Continue
Japan is the world's largest creditor with $130 billion in net long- and short-term
foreign assets, and we expect capital outflows to increase slightly over the next six
months. Yen appreciation, which is fueling a near-term expansion in the current
account surplus, has helped supply the Japanese with funds to boost overseas
investments (see figure 1). Japanese institutional investors, who were responsible for
the bulk of the $65 billion net outflow of long-term capital during 1985, are clearly
eager to boost their overseas holdings. Press reports indicate that trust banks and
insurance companies--which together manage pension funds worth over $80
billion--are actively trying to move away from the heavy concentration on domestic
investments that resulted from Finance Ministry regulations restricting capital outflows
The Japanese Government also seems ready to facilitate growing foreign
placements. In an effort to dampen criticism of Japan's massive trade surplus, officials
in Tokyo have publicly emphasized that Japanese capital exports--the flip side of the
surplus--play an important role by making up for saving shortages in other countries.
Japanese officials have another reason for encouraging outflows--to reverse some of
the appreciation of the yen that has occurred over the past year. To this end, the
Finance Ministry has eased guidelines that in the past acted as a brake on offshore
investment activities:
? The Finance Ministry now allows life and non-life insurance companies to put 30
percent of their portfolios--instead of the previous 25 percent--into foreign
bonds. Trust banks will be able to expand their holdings of non-yen securities by
the same percentage.
? The Ministry of Posts and Telecommunications--responsible for overseeing the
huge postal savings system--has removed the 20-percent ceiling on investment
in foreign securities by the postal pension fund. The respected financial daily
Nihon Keizai Shimbun estimates the change will boost postal pension fund
investments in foreign securities by over $7 billion dollars annually.
? Effective 1 October, foreign exchange banks can, within proscribed limits, convert
yen funds into other currencies and use the proceeds to buy foreign bonds.
Finance Ministry officials believe, according to press reports, that the recent changes
may gradually boost the foreign securities held by Japanese by at least $25 billion, a
50-percent jump in current holdings.
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Figure 1
Japan's Current Account and Net Long-Term
Capital Outflows, 1985-86
JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB MAR APR MAY JUN JUL AUG
1985 1986
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Legend
CURRENT ACCOUNT
LONG TERM CAPITAL
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With Japanese assets large and likely to grow, the potential that shifts in
placement will unsettle international financial markets increases. Japanese investment
practices in the last year, however, suggest that despite exchange and interest rate
changes, Japanese capital outflows have generally remained focused on the United
States (see figure 2). Some industry analysts had expected Japanese investors' to avoid
US assets and to sell currently held bonds until the yen reached a plateau. In 1985,
however, over 50 percent of Japanese net long-term capital outflows were invested in
the United States--a sizable increase from the previous 30 percent share in the United
States in 1984.
Japan's financial liberalization program, which has been gaining momentum in the
wake of the 1983 Yen/Dollar accord, is probably a major factor accounting for the
emphasis on investment in the United States. In particular, it has improved the ability of
investors to hedge against exchange and interest rate fluctuations, making overall capital
outflows relatively stable despite swings in these variables:
? According to press reports, many investors are using "impact" loans to protect
their portfolios. The loans, denominated in a foreign currency, allow the investor
to take advantage of higher US interest rates while avoiding losses that could
result from exchange rate changes.
? Fixed-rate currency and coupon currency swaps--exchanging the proceeds from
debt in one currency for payment in another currency carrying either fixed or
variable interest rates--provide other ways for investors to avoid foreign
exchange risk in investments. For example, a Japanese insurance company that
has invested in US securities might swap the dollar interest payments it is due
for a guaranteed amount of yen at a future date.
? Finance Ministry permission, granted in November 1985, for banks and securities
firms to trade financial futures contracts in the overseas markets also has
enabled investors to hedge against fluctuating exchange and interest rates. For
instance, a bank could use a futures contract for dollars to lock in a set exchange
rate several months in advance.
Despite the public evidence I that indicates
that US assets remain a favorite of Japanese investors, some financial analysts believe
their allure could fade. As a case in point,
the Japanese were shifting their investment portfolios from US dollar
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Figure 2
Japan: Exchange Rate and Net Long-Term
Capital Outflows, 1985-86
14000 -~
12000 4
V) 10o00 -a
2000 H
o-i
JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB MAR APR MAY JUN JUL AUG
1985
1986
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We are skeptical that the Japanese will diversify away from US assets soon,
despite the higher interest rates offered elsewhere. We believe Japanese investors
value the low risk of US assets. For many of the larger Japanese investors, such as
insurance companies, the longer maturity offered by some US Government securities
continues to make them attractive as instruments for covering long-term liabilities. We
expect the poor performance of the Australian economy--because of low world
commodity prices and a heavy government debt burden--will also be a major deterrent
to increased Japanese investment in Canberra's financial markets, as will the small size
of Australian as well as Canadian and New Zealand financial markets.
In our view, long-term goals will also encourage Japanese institutional investors
to continue focusing on the United States. several top
Japanese securities firms plan to make a major effort to win the US Federal Reserve
Board's blessing as primary US Treasury bond dealers. their goal is
to become major players in the US primary securities market by 1990, a goal that is also
publicly espoused by Japanese securities firms' executives. The strong showing of the
Japanese in the $9 billion US Treasury 30-year bond issue on 8 May--the Japanese
bought an estimated two-thirds--appears to bear out this assertion. As a result, we
also give some credence to the prediction that US Treasury securities
investment will continue to compose over 60 percent of all Japanese overseas
investment through the end of the decade. the
Japanese are increasingly interested in US real estate as well. For example,
during 1986.
Japanese banks plan to invest as much as $5 billion in US property
But Anything Can Happen
With Japan's current account surplus likely to top $80 billion this year, we expect
Japanese capital to continue to flow to the United States at roughly the present levels
in the coming months. Several factors, however, could cause the magnitude of Japan's
capital outflows to change over the next year:
? A major increase in domestic demand in Japan--admittedly unlikely, unless Tokyo
loosens its fiscal policy--would mean that more capital would be needed in
Japan for investment, driving up interest rates and making investors more likely
to keep excess funds in yen assets.
? A sudden run-up in oil prices and thus in Japan's energy import bill would soak
up some of the proceeds from Japan's trade surplus, leaving less for the
Japanese to invest abroad.
More likely, however, are several developments that would encourage Japanese
investors to send more funds to the United States:
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? A cut in Japan's discount rate. This likely prospect could easily widen the
US-Japan interest rate differential and, as such, encourage additional capital
flows to the United States.
? Heightened expectations of the yen depreciating against the dollar at a later date.
This view already is the conventional wisdom among Japanese financial
institutions, If others come to share it, the result
could cause Japanese, hoping to benefit from exchange rate changes, to invest
money in US markets.
? A worsening of the Third World debt crisis. Lower commodity prices or higher
international interest rates affecting developing countries could drive Japanese
into heavier investment in the safer OECD markets. Between 1982 and 1984,
largely in reaction to the LDC debt crisis, Japanese banks reduced the Third
World share of their medium- and long-term foreign loan portfolios from 54
percent to 50 percent
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Title: Japanese Capital: Still Flowing Freely to the United States
1 - Joseph Massey, USTR
1 - Bob Park, Intelligence Liaison, USTR
1 - Donald Gregg, Office of the Vice President
1 - Thomas Hubbard, Department of State
1 - William Brooks, Department of State
1 - Chuck Kartman, Department of State
1 - Marshall Casse, Department of State
1 - Robert Reis, Department of State
1 - Nicholas Riegg, Department of State
1 - James Kelly, Special Assistant to the President, NSC
1 - Cdr. (Ret.) James Auer, DOD/ISA/EAP
1 - Stephen Danzansky, National Security Council
1 - Lou Pugliariesi, National Security Council
1 - Byron Jackson, Department of Commerce
1 - Maureen Smith, Department of Commerce
1 - Doug Mulholland, Department of the Treasury
1 - Patricia Haas, Department of the Treasury
1 - Richard Woodward, Department of the Treasury
1 - National Security Agency
1 - David Germany, Council of Economic Advisers
Central Intelligence Agency
1 - Director, DCI/DDCI Executive Staff (7E12)
1 - NIO/EA, 7E-62
1 - NIO/Economics
1 - C/EAR 5E-18
1 - OGI/ECD/IF
1 - OEA/NEA/Korea Branch
1 - OEA/NEA/STI Branch
1 - OEA/NEA Division
1 - OEA/China Division
1 - OEA/SEA Division
1 - D/OEA, 4F-18
1 - C/Production/OEA
1 - FBIS Analysis Group
1 - DDI, 7E-44
1 - Senior Review Panel, 5G-00
1 - PDB Staff, 7F-30
1 - C/PES, 7F-24
1 - CPAS/ILS, 7G-50
5 - CPAS/IMC/CB, 7G-07
1 - Branch
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2 - Author
1 - Chrono
DDI/OEA/NEA/Japan
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