U.S. trade policy and influential American economists are obstacles to creating a system to enforce a trading band for yen-dollar exchange rates, according to Kenichi Ohno, an advocate of such a system.
“Technically, it is easy to stabilize the yen-dollar rate,” maintains Ohno, a professor at the National Graduate Institute for Policy Studies in Tokyo and a former International Monetary Fund economist. The problem is a lack of political commitment and a “philosophical” conflict among economists over how foreign exchange should be used, he said.
The need to stabilize foreign exchange rates was agreed on by Asian and European finance ministers at a meeting in Frankfurt, Germany, earlier this month. The topic is expected to dominate the Group of Seven meeting of finance ministers scheduled for Feb. 20 in Bonn and also a June summit in Cologne, Germany.
Ohno said finance chiefs from Japan, the U.S. and Europe should declare at the G7 meeting that they will continue long-term negotiations to phase in a stabilizing mechanism. A stable exchange regime involving the yen, dollar and euro is the key to a stable world economy, he stressed.
However, Ohno said it is unwise to push the idea of an exchange rate “target zone” now. He proposed a yen-dollar target zone in a 1997 book coauthored by Stanford University Professor Ronald McKinnon titled “Dollar and Yen: Resolving Economic Conflict between the United States and Japan.”
According to the proposal, the zone would be permanently set, for instance from 110 yen to 140 yen to the dollar, or in a narrower range. Both the Japanese and U.S. governments would then make sure the rate stays within the band by jointly intervening in the market if the rate appears to be breaking out, except at a time of unusual economic crisis. “Opposition is so strong that the scheme should fail,” Ohno said, suggesting phased, loose currency management instead. “In the foreign exchange market … when you do something that many people say will fail, it is bound to fail.”
The opposition forces include prominent U.S. economists who exert overwhelming influence on policymakers and the financial markets, he said.
Their basic position is that foreign exchange rates should be flexible and used as an instrument of trade policy to adjust trade imbalances, according to Ohno. They believe a weaker dollar and a stronger yen can shrink the U.S. trade deficit with Japan. But Ohno insists this thinking is wrong, asserting that the U.S. deficit is structural and cannot be corrected by the exchange rate.
Backed by these economists, the U.S. government tends to talk up the yen to mitigate protectionist pressure from industrial lobbies when imports rise, he said.
Ohno believes the unstable yen-dollar rate has directly or indirectly caused the “ever-higher yen syndrome” in recent decades, including the asset bubble, fiscal deficit and banking sector crisis in Japan. The “syndrome” has also contributed to the Asian currency crisis and financial instability worldwide, he reckoned.
In fact, Japan and the U.S. have jointly intervened in the currency market a number of times to reverse excessive appreciation or depreciation of the yen against the dollar.
But Ohno said the intervention has been ad hoc, and the U.S. has cooperated only after Japan and the rest of the world suffered considerably and the U.S. economy was threatened.
There also remains too much uncertainty about future exchange rates, a persistent negative factor for Japanese export and business investment abroad.
There is opposition to the target zone approach in Japan and Europe as well, partly because of the belief that the system would be vulnerable to attack by speculators. Speculative attacks occur when investors try to sell either yen or dollars beyond the band, believing the governments will not be able to defend it.
But Ohno claims such attacks would be unlikely if monetary authorities firmly commit themselves to the target zone and at the same time conduct adequate monetary policies to check inflation.