TOKYO -- Japanese Finance Minister Kiichi Miyazawa must have felt a tad embarrassed this weekend during his powwows with other Group of Seven finance officials in Washington. He had good reason to be out of sorts, having just been humiliated in a bruising battle over monetary policy with his central bank.
For weeks, Ministry of Finance officials had been touting the importance of expanding the money supply in Japan to stem the yen's precipitous rise against the dollar, a development threatening to choke off this country's fragile recovery. By putting more yen into circulation, the theory goes, supply increases. And without a commensurate rise in demand, the value of the currency, like that of any commodity, falls.
Since early July, the yen has climbed roughly 15% against the dollar on expectations that this economy is finally headed toward recovery. While everyone welcomes the optimism, a strong yen also spells trouble for Japan's turnaround. Suggesting a heavy dependence on export-led growth, Japanese brokerages estimate that every 10% appreciation of the yen can shave as much as 0.9% off GDP growth.
Enlisting the help of key players in the ruling Liberal Democratic Party, the MOF orchestrated a surprisingly public and mean-spirited campaign against the Bank of Japan to get it to loosen monetary policy."Official sources" here were also shamelessly playing the foreign-pressure card, planting tantalizing-though-unsubstantiated rumors in the media that U.S. Treasury Secretary Lawrence Summers was prepared to jointly intervene with Tokyo to weaken the yen as a quid pro quo for monetary expansion. The MOF's onslaught focused market attention on monetary easing and raised expectations that the once almighty ministry would ultimately prevail in its bid to browbeat the BOJ into submission. Wrong! After last Tuesday's central bank policy board meeting, BOJ Governor Masaru Hayami essentially told the MOF to get stuffed. He pointed out that with the overnight call rate at nearly zero, there is already plenty of liquidity in the economy and that an expansion of the money supply now would have little meaningful impact -- the classic pushing-on-a-string argument. Sticking his thumb in Miyazawa's eye, he also asserted that "manipulating exchange rates is not an objective of monetary policy." Unsurprisingly, within minutes of the BOJ's official announcement last week that its monetary policy would remain unchanged, the yen jumped to 104 on the dollar from 107. How did the MOF get it so wrong? Lingering institutional arrogance is one of the biggest reasons. In the past, the MOF dominated monetary policy and the BOJ. But in the spring of last year, the central bank finally won legal independence from the MOF. Hayami's intransigence last week was an unambiguous signal to the ministry and the politicians that his bank wasn't going to be pushed around anymore. What's really remarkable about the MOF's attempt to bend the BOJ to its will is that the more strident the ministry became, the more it pushed Hayami into a corner to defend the integrity of his institution. Had he buckled under pressure to deal with Japan's short-term currency problems, the BOJ's reputation over the long term would have been badly tarnished. It's no wonder Hayami stood his ground. There's no telling if the BOJ would have caved to the MOF had this nasty catfight occurred behind closed doors, but at least it wouldn't have raised market expectations that a monetary shift was in the works. In this country, which places a high premium on saving face, the MOF's behavior came across as a pompous miscalculation that undermined international confidence in Japan's monetary and exchange-rate policies. It also left Miyazawa with no goodies to deliver to Summers in Washington this weekend. It's entirely unclear if the treasury secretary would have been impressed enough with a shift in Japanese monetary policy to jointly intervene in the currency markets. Summers has never been terribly fond of intervention, particularly if he's uncertain that such a move would have a good chance of success. Nevertheless, Miyazawa was left empty-handed and in no position to ask for any favors from America's treasury chief. A lot more was at stake for the MOF than reasserting control over the BOJ and reversing the yen's rise. Panicked about this country's shrinking tax base and its heavy reliance on spending packages, the MOF desperately wants to further relax monetary policy to get this economy back on its feet. The Organization for Economic Cooperation and Development, or OECD, projects that Japanese government debt as a percentage of GDP in 1999 will be a whopping 110% -- twice as much as the U.S. Without monetary easing as an option, Japan's ruling coalition, with an election on the horizon, will have even more incentive to open wider the public spigots and drive the nation deeper into the red. Given Hayami's determination to stay the course and the MOF's botched job of getting him to change his mind, Japan has no tools left to influence the exchange rate. Sure Tokyo can continue intervening unilaterally. But that seems pointless. During the past three months, the government has purchased an estimated $30 billion in solo interventions and the yen has kept strengthening. So the fate of the yen/dollar rate is up to the markets and the judgements of Summers. And that seems to be just fine by Hayami for the time being.