Disarray over yen in Japan
The yen has come back into fashion since last year when it fell to 144
The Japanese government and the Bank of Japan are deeply split over whether to intervene in currency markets to curb the rising yen.
The government fears that the more expensive currency will hurt Japanese exporters who are the driving force pulling the country out of recession.
But the Bank of Japan believes that currency intervention is pointless, and that government proposals would be inflationary.
It sees the dispute as a test case for its recently granted independence.
The dispute is surprising in Japan, where economic policy-makers usually operate in harmony, following the dictates of the powerful Finance Ministry.
Policy split
While the dispute simmers, the currency markets continue to push up the yen, as money flows into the Japanese stock market.
On Thursday, after strong Japanese growth figures, the yen reached an eight month high against the US dollar. One dollar now buys just ¾108.54 - nearly 13% less since the summer.
The markets believe that with Japan emerging from recession and the US economy slowing down, the fundamentals are all on the side of the yen.
While the uncertainty about both US and Japanese policy persists, the markets will continue to test the limits of intervention.
"The real problem is that the bank does not seem to have a clear policy framework right now - people do not understand what it is trying to do," says Jesper Kroll of Merrill Lynch.
The Japanese government has said it would like to keep the yen at around ¾120 to the dollar - a level its export firms would feel comfortable with.
But repeated interventions by the Bank of Japan in June and July failed to stop the currency's rise.
Now the bank is digging in its heels at proposals for further loosening of monetary policy which could weaken the currency.
"The bank and the ministry appear to be following different policies" says Brian Rose of Warburg Dillon Read.
But the bank is adamant that it will not give in to Ministry pressure.
"Our policies might make us unpopular in the short-term, but in the long term they will give us credibility because they show we are independent", said an official.
No Funding of Public Debt
The Bank of Japan is even more opposed to suggestions that it buys up more Japanese government bonds, which it calls "monetarisation" of the debt.
The bank would then effectively be bankrolling the government's growing budget deficit.
Masaru Hayami, the central bank governor, has threatened to resign if the government tries to force that proposal through.
Observers of Japan insist that even with interest rates at nearly zero, not enough is being done to stimulate the economy. And, they say, a bout of inflation could be useful for an economy which is experiencing deflation.
Hubert Neiss, the IMF Asia director, says the next time the Bank of Japan buys yen, it should use the move to expand the money supply.
The government, though, seems determined to borrow even more money in an attempt to boost the economy, with another aid package scheduled for the autumn.
Yen roller coaster
The rise of the yen is also of concern in Washington, where the strong dollar policy has been reaffirmed by the new Treasury Secretary Lawrence Summers.
But many observers believe that a strong yen would not be unwelcome to the Clinton Administration. As the dollar weakens, it would price some Japanese imports out of the US market and help to contain the US trade deficit, which is approaching a record $200bn this year.
And even if the US wanted to strengthen the dollar, it would find it difficult to buck the markets at this stage - far more difficult than when it last intervened, in June 1998, to prevent the yen falling too far.
'The fundamentals do not line up for the dollar they way they did before,' says Allen Sinai of Primark Decision Economics. 'The question for (Treasury Secretary) Summers, from a market point of view, is whether what he says about the dollar, if he says anything at all, is credible against the reality of the changed situation.'
As the yen surges towards ¾100 to the dollar, the credibility of the new Japanese and US policy-makers could be put to its first real test.
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