Yen Bloc: Toward Economic Integration in Asia

Chapter 6: A Japanese Perspective

My study of the possibility of forming a yen bloc from a Japanese perspective focuses on the implications for Japan itself of forming a monetary union with Asia.1 If the benefits exceed the costs, then Japan would be likely to pursue it as a policy objective and try to remove barriers hindering its realization. With Asia now replacing the United States as Japan’s largest trading partner, stabilizing the yen’s effective exchange rate through the formation of a yen bloc should help insulate the Japanese economy from the adverse effects of fluctuations in the yen-dollar rate. In addition , increasing the use of the yen as an international currency should make it easier for Japanese companies and banks to manage their foreign exchange risk in international transactions and facilitate the development of Tokyo as an international financial center. Growing recognition of these benefits has prompted the Japanese government to adopt ambitious measures to reform and liberalize its financial system. The Internationalization of the Yen The Japanese government’s stance on the internationalization of the yen has shifted from reluctance to approval. At the same time, more emphasis is 109 6 A Japanese Perspective 1. This chapter draws heavily from the official report of the Council on Foreign Exchange and Other Transactions on the internationalization of the yen. See MOF (1999).      placed on promoting the use of the yen in Asia. However, incommensurate with Japan’s status as an economic power and the world’s largest creditor country, the use of the yen as an international currency lags far behind the dollar and the deutsche mark. From Reluctance to Approval Throughout the 1970s and 1980s, Japan’s official stance on the use of the yen as an international currency can at best be described as neutral if not passive. While accepting the international use of its domestic currency as a “natural development,” the authorities were concerned that the massive inflow and outflow of funds would destabilize the yen in foreign exchange markets as well as undermine the effectiveness of monetary policies by weakening their control over the domestic money supply. It was only under U.S. pressure in the 1980s that concrete steps were taken to promote the international use of the yen. However, major changes in the economic environment toward the end of the 1990s prompted the government to pursue the internationalization of the yen as a policy priority based on its own costbenefit considerations. Interest in the international role of the yen was first sparked in the discussion seeking a new international monetary system in the wake of the collapse of the Bretton Woods system in the early 1970s. Cross-border capital account transactions, including those involving the use of the yen, were liberalized to a large extent in December 1980, when the Foreign Exchange and Foreign Trade Control Law was substantially revised for the first time in thirty years. Subsequently, the U.S. trade deficit surged on the back of a strong dollar under President Ronald Reagan’s policy mix of tight monetary policy and loose fiscal policy in the first half of the 1980s. It was against this background that the U.S. government put pressure on Japan through the Yen-Dollar Committee to promote the use of the yen as an international currency, hoping that the resulting increase in the demand for the yen would keep it from falling further against the dollar. An agreement was reached in May 1984 between the two governments concerning the liberalization of Japan’s financial and capital markets, the internationalization of the yen, and the lowering of the barriers to access for foreign financial institutions participating in Japan’s financial and capital markets. As a follow-up to the Yen-Dollar Agreement, in March 1985 the Council on Foreign Exchange and Other Transactions proposed the following specific measures for promoting the internationalization of the yen: financial liberalization (particularly the continued liberalization of interest rates and the further development and expansion of open short-term money mar-     kets); liberalization of Euro-yen transactions as the first step toward improving the convenience of the yen for nonresidents; and establishment of a Tokyo offshore market to facilitate Euro-yen transactions in Tokyo.2 Subsequently, these measures were implemented as scheduled but with only limited success in achieving their goal. It was not until the implementation of Japan’s financial Big Bang, the onset of the Asian currency crisis, and...