Record currency interventions subsidizing U.S. debt, but experts warn flows unsustainable

By: AUDREY McAVOY - Associated Press | Thursday, February 12, 2004 9:34 PM PST ∞

TOKYO -- Japan is on an unprecedented spending spree, all focused on the same product: the U.S. dollar.

Tokyo bought an astounding $172 billion last year to keep the yen from strengthening too much against the greenback. The push only accelerated in January, when Japan snapped up another $67 billion.

That Japan's government is buying dollars to prevent a stronger yen from smothering a feeble economic recovery at home is not new. But the scale of the current round is far beyond its earlier interventions.

The purchases are so large they are effectively subsidizing record U.S. budget and trade deficits, keeping American interest rates low and worrying some experts that a painful shock will hit if the spending spree stops.

"We are standing on a delicate balance," said legislator Kohei Ohtsuka, an upper house finance committee member and a former Bank of Japan official. "If this situation were a miniature model, it would be in danger of falling apart if we removed just one small part."

A key part of that model is the fragile Japanese economy, which has wallowed in the doldrums for more than a decade. The world's second-largest economy, however, has shown signs of recovery recently, built on increasing exports of cars, steel and electronics.

The decline of the dollar threatens that by making Japanese products more expensive in prime markets like the United States and China. So as other investors sold the dollar out of worries about burgeoning U.S. deficits, Japan has spent record amounts to buy it.

While that hasn't stopped the dollar from falling, it has limited its drop against the yen to 12 percent since January 2003. In contrast, the dollar sank 23 percent against the euro during the same period.

A byproduct of the policy has been a jump in Japan's holdings of U.S. debt as Tokyo has poured its new dollars into the Treasury market.

Japanese investors -- mostly the government -- bought a net $104 billion in U.S. debt between January and October, according to calculations by Japan's Nihon Keizai newspaper. That's a third of the $314 billion in fresh debt Washington issued during that period.

There have been other effects. John Vail, senior strategist at Mizuho Securities, a brokerage unit of Japan's largest bank, said the yield on the benchmark U.S. bond would now be about 6 percent instead of 4.1 percent if Japan hadn't been so active in the foreign exchange and bond markets over the last 13 months.

That means that if not for Japan, U.S. consumers would be facing higher interest rates on their home mortgages and credit cards.

"If they weren't keeping their money in dollars, interest rates would be higher across the board," Vail said from his office in Chicago.

The dollar-buying spree is having side effects in Japan as well. U.S. investors are plowing cash into Japanese shares with the cheap money they've borrowed in the United States, boosting the Tokyo stock market.

Foreigners -- primarily Americans -- bought a net 8.213 trillion yen ($77.36 billion) in Japanese stocks last year, according to the Tokyo Stock Exchange. This was the second highest since the bourse started disclosing such data in 1981 and the most since 1999.

Ironically, these flows drive up the value of the yen, prompting Tokyo to intervene even more in the currency market.

Some of the risks are obvious. If Japan stops buying as much U.S. debt, both Washington and the private sector will have to pay more to borrow.

"There is a chance Americans will suffer a shock when and if Japan stops intervening and its demand for Treasurys tapers off," said David Parsley, associate professor of economics at Vanderbilt University.

The higher rates would force Washington to dedicate more resources to paying the interest on its debt, taking funds away from other programs and dampening the economic recovery in the United States.

Eisuke Sakakibara, an aggressive interventionist during his tenure as Japan's vice-finance minister for international affairs from 1997 to 1999, also noted that the Finance Ministry's activism cannot last forever.

"You have to think of an exit policy sometime," he said. "It distorts the market. It takes the vitality out of the market. It has an unnatural impact on the U.S. bond market."

But Sakakibara's successors are showing no sign of letting up. Parliament said this week that it would allow the Finance Ministry to draw another 21 trillion yen ($200 billion) on a special account used for intervening.