Anyone who thinks Treasury Secretary Paul O'Neill is lying awake at night, fretting over the

yen's decline is in deep need of mental flossing.

Don't get me wrong. O'Neill and the Treasury care about the dollar/yen relationship. Surely after complaints from China, Hong Kong, Malaysia, South Korea and U.S. manufacturers about the yen's decline, they probably care a bit more.

But the Bush administration is generally far more concerned about getting Japan, the world's second-biggest economy, back on a growth track. Despite politically inspired official U.S. optimism about the U.S. recovery, Bush economists and Treasury officials share, off the record, Federal Reserve Chairman Alan Greenspan's concerns about downside risks, and they recognize the very high probability that the recovery will be gradual.

This is not good news for the outlook in Asia, excluding Japan. Without the U.S. economy growing at 4%, Asia needs Japan to pick up the slack now more than ever.

Quiet Tolerance

Yes, the Bush administration has been quite silent on -- and even tolerant of -- the yen's slide. It will continue to be tolerant of yen weakness as long as it's the outcome of Japan's policy mix and structural reform. O'Neill and the Treasury will have a problem if Japan makes yen weakness the strategy for restoring growth.

So far, Japan hasn't done that. However, it has been guilty of manipulating the currency lower, and this may draw private criticism next week. Still, that won't be the crux of the message the U.S. brings to Japan. Bank reform, accommodative monetary and fiscal policy and fiscal reform (tax cuts) are surely the prescription O'Neill will emphasize, albeit politely, when he visits Tokyo for a conference next week.

Few rational people believe Japan's ticket out is a weaker yen. With weak global demand, a much larger decline in the yen is needed before exports respond. As far as domestic inflation goes, weak demand at home would require a soaring dollar/yen exchange rate for Japan to experience a positive rate of inflation. Getting there would risk disruptions to Japan's fragile stock market and bubble-like bond market. Believe it or not, foreign investors still own plenty of Japanese stocks and government bonds, and they'll sell if the yen collapses.

Indeed, the recent jawboning by Japanese officials over the pace of the yen's decline -- and, to a far lesser extent, the level of dollar/yen -- reflects this very concern, as officials fear foreign selling of Japanese stocks and bonds at fiscal year-end would be hugely counterproductive. Furthermore, a collapsing yen would surely ignite competitive devaluations in Asia, led by China and possibly Hong Kong.

Shedding Light on Guidance

If everyone knows that the yen isn't the key to a Japanese recovery, then surely Japanese officials do, too. So why did they guide the yen lower in the fourth quarter of 2001? Japanese Prime Minister Junichiro Koizumi needs to project an image that his government is being proactive. He has his own manufacturing lobbyists to placate, and a weaker yen offers some lift at the margin for exports and prices.

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But perhaps the main reason for guiding the yen lower was to short-circuit what was looking like a yen rally. The yen presents asymmetric risks for the Japanese economy. With Japan in deflation, a stronger yen is a far greater risk to the short- and long-run health of the economy than a weaker yen. In the summer, dollar/yen went from 126 to 116. Something had to be done.

For the time being, Japan can placate its neighbors' concerns and check the whining with a 130-133 range for the rest of the fiscal year. But its motivation is self-interest -- not compassion for vulnerable economies in Asia or for companies such as


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The dollar/yen exchange rate will likely resume its ascent in April until O'Neill registers a protest. When he does, don't look for him to state publicly that the yen is weak enough. That'll come from Japanese officials, including Finance Minister Masajuro Shiokawa and Haruhiko Kuroda, the vice finance minister for international affairs, probably when dollar/yen is above 140.

David Gilmore is an economist and partner of Essex, Conn.-based Foreign Exchange Analytics, a currency markets advisory service for institutional investors. Neither the author nor Foreign Exchange Analytics trades in the currency markets. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to