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To: Alex who wrote (12631)	6/5/1998 9:15:00 AM
From: Gabriela Neri	Read Replies (1) \| Respond to of 116815

Will China Devalue? Thanks to Steve Roach from Morgan Stanley. Global: The Perils of a Weak Yen Stephen Roach (Lake Como) Many have jumped aboard the weak-yen bandwagon in recent days. US Treasury Secretary Robert Rubin, remains unflinching in support of a strong dollar. Japan's Eisuke Sakakibara, better known as "Mr Yen" of the MOF, has finally conceded that the days of a strong yen are probably over. World financial markets have rendered a similar verdict, taking the yen/dollar cross rate from the low 120s at the start of the year to within a rounding error of the key 140 threshold. It seems the world has now come around to the view that the "correct" value of the yen is whatever level it takes to get the Japanese economy going again. In my view, there are three reasons why this is a very risky course. First, and foremost, a weak yen lets Corporate Japan off the hook. When the yen had soared to 79 against the dollar in the spring of 1995, Japanese businesses had their back to the wall. Under endaka ("strong yen"), it was restructure or perish. But now with the yen having depreciated nearly 45% against the dollar over the subsequent three years, the imperatives of restructuring have diminished sharply. As a result, there is now less of an urgency to dismantle the linchpin of Japan's antiquated corporate culture -- the social contract of lifetime employment. A strong yen was the lever that could have changed Japan's employment practices. A weak yen tampers with the necessity of such critical structural change. Second, a weak yen would put Japan on a geopolitical collision course. That's because it lessens the need to stimulate domestic demand and allows Japan to reflate by relying increasingly on its external sector. Such classic "beggar-thy-neighbor" tactics leave Japan attempting to achieve an export-led recovery at the cost of taking market share away from its major trading partners. With the momentum of the global business cycle now tipping to the upside in most major segments of the industrial world, any objections to Japan's mounting current account surplus are likely to be muted. However, once the business cycle begins its inevitable downleg, the verdict could be quite different. That's especially likely to be the case in the United States, where trade deficits are now hitting new records with each passing month; while that's no big deal with an unemployment rate at a 28-year low, it could be a very different matter altogether once joblessness begins to rise again. Third, a weak yen could well be the spark that triggers yet another round of destabilizing revaluations in world foreign exchange markets. We've certainly had a whiff of that in recent weeks with currency contagion once again rearing its ugly head throughout non-Japan Asia and spreading into parts of Latin America and Central Europe. Moreover, most investors are convinced that a further weakening of the yen could well be the force that prompts China to rethink its position on the renminbi -- thereby unleashing the most lethal dynamic of all. On this latter count, I continue to believe that the fears of a tight leakage between the yen and the renminbi are overblown, mainly because China and Japan enjoy little competitive overlap in world trade. But to the extent that a further sharp weakening of the yen prompts contagious contractions in the currencies that bear more critically on China's export capacity -- especially the Korean won or the new Taiwan dollar -- fears over the stability of the renminbi would only intensify. However, to the extent the Chinese exceed in defending their currency, the coming reality check should convince investors that the yen-meltdown scenario can be avoided. But I am the first to concede that under a weak yen scenario, it will take all the more to persuade investors that China will not go that way of the rest of Asia. In the end, you have to ask what Japan, Asia and the world gains from a further progressive weakening in the yen. My sense is that such an approach is nothing more than a big global cop-out. It largely reflects the meager initiatives of Japanese fiscal and monetary authorities, as well as the reluctance of US policy makers to just say no to the predatory tactics of currency devaluation. Moreover, it defers Corporate Japan's day of reckoning, while heightening the risks of global trade frictions and currency contagion. In short, a weak yen strategy is a heck of a way to run the world economy, in my view. Let's hope the G-7 sees the other side of this trade.