"Japan Investors Scurry Into Pre-Euro Currencies" -
Rejection of Dollar Could Reverberate in U.S.
Paris, Saturday, December 19, 1998
By Philip Segal International Herald Tribune
HONG KONG - Earlier than many observers expected, Japanese investors are shifting out of U.S. dollars and into the currencies of Europe, a move that threatens a weaker American currency even before the euro is introduced at the end of the month.
What appears to be driving the move into the European single currency is an increasing belief that it will be popular with central banks seeking to balance and diversify their holdings of reserves - now held mostly in dollars. The euro also appears to be gaining favor with borrowers who previously depended on dollar-denominated bond markets and will now have the choice of a new more, highly liquid market denominated in euros.
A major exodus from the dollar into the euro by Asians, and in particular by Japan, ''is the one thing the Americans walk in great fear of at the moment,'' said Noriko Hama, an economist at the Mitsubishi Research Institute in Tokyo. ''I would suspect there have been requests on the part of the Americans to the Japanese not to do this sort of thing.''
What makes a big move into the euro frightening for Washington is that Japan is the world's second-largest holder of U.S. Treasury debt, with $264.5 billion, after Britain. Enough sales of U.S. bonds could depress prices and drive up American interest rates, just as the U.S. Federal Reserve may feel the need to cut rates to keep the world's largest economy from sliding into deflation and recession.
The change of heart in Japan toward currencies that will be fixed to the euro has been dramatic: In May, Japanese investors bought $5.6 billion in U.S. medium- and long-term bonds, and just $3.3 billion in combined French and German debt. By October, according to Japanese Ministry of Finance figures released this week, the Japanese were net sellers of U.S. debt, but bought $7.8 billion worth of French and German bonds.
There is more than $2 trillion available in Japan to move into the euro. Analysts also estimate that at least three-quarters of the world's foreign currency reserves in the vaults of Asia's central banks now sit in dollars.
In another sign of the euro groundswell, Japan's largest life insurer, Nippon Life, said Tuesday that it would consider moving half of its $34 billion in overseas assets into euros, based on the fact that euros and dollars have about equal weighting in the Salomon government bond index.
Currently, the company invests about 30 percent of that money in currencies that will become fixed to the euro at the end of this month.
Japan, along with China and other Asian countries with major holdings of dollar reserves, may figure that ''if you spread your bond holdings you reduce your risk against currency fluctuation,'' said Paul Mortimer-Lee chief capital markets economist for Banque Paribas in London.
But for Japan, the move into the euro may make sense on an additional
level. Christopher Wood, managing director at ABN Amro Asia in Hong
Kong and the author of two books about Japanese finance, called the move ''partly sensible diversification, and partly geopolitical, because they're fed up with being told what to do by the United States.''
Japan is on the receiving end of endless pleas by the U.S. government to fix its banking system to roust the economy out of recession, but it remains one of the major financiers of America's bulging current account deficit. Japan sells the U.S. more goods than it buys, and then invests many of the dollars it earns into U.S. bonds. And that, too, could impact its inclination to invest in euros.
The U.S. ambassador to Japan, Thomas Foley, in a speech Monday,
warned that the rising trade imbalance between Japan and the United States could lead to increased frictions between the countries next year. In October, Japan's trade surplus with the United States was $6 billion, up 32 percent from a year ago.
In the event of U.S. trade sanctions against Japanese exports, in retaliation for higher duties on rice imports into Japan or other trade irritants, Japan may feel more comfortable holding more euros, which would reflect an increasing dependence on trade with Europe.
''What will make the euro a reserve currency is the fact that a substantial amount of Asian trade will be denominated in euros, whereas a tiny proportion of Asian trade was denominated in Deutsche marks,'' said Avinash Persaud, global head of currency research at J.P. Morgan in London.
But too strong a stampede out of the dollar would pose the threat of an overvalued euro, said Mrs. Hama at Mitsubishi.
''We may end up with competitive devaluations between the euro and the
dollar,'' she said. The yen could become ''excessively overvalued'' as a result, she added, making it even harder for Japan to export its way out of recession.
Given the uncertain outlook for both the dollar and euro, Asian countries may also wish to reduce their reliance on dollar reserves out of a general recognition, reiterated Tuesday by the Japanese finance minister, Kiichi Miyazawa, that pricing currencies solely in terms of one currency proved unwise in the run-up to the Asian financial crisis.
As the dollar strengthened against the yen and most European currencies in the mid-1990s, exports from Asia slowed sharply because most countries in the region had partially linked their currencies to the dollar. Eventually, the current account deficits that resulted touched off a loss of confidence among investors and the consequent crisis.
Mitchell Martin contributed to this report from New York.
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