Japanese paper for Session 1

Of the 6^th Trilateral forum, Berkeley Meeting

Teruhiko Mano

Advisor to the President

The Bank of Tokyo-Mitsubishi, Ltd.

1. Based on discussions of the past five forums and the content of our final proposal report, I would like to express my opinions on session 2 in terms of international finance and the exchange rate system.

My basic stance has not changed from the one I described at last December's conference in Shanghai. Namely, while there is a firm understanding that the economic disorder caused by the economic disarray that began in Central Asia in 1997 originates from the peculiar conditions of Asia, I asserted that this issue is worldwide disorder that an imbalance of commodities and money engenders. The factual relationships thereafter substantiate this. The Asian problem spread from Russia to Central and South America and also to the breakdown of US hedge funds, and expanded from a regional issue to one of international proportions.

Considered from the speed of its impact and the magnitude of the disarray, it is clear that the deterioration of the substantial economy originates in the movement of colossal funds. The reason why the economic problems of Russia, which has little noteworthy business results in terms of the exchange of funds, trade or people, extended to Central and South America, originated in investors' expectation that fund withdrawing from the former is also likely to occur in the latter.

That the expansion of trade and investment is essential for the development of the global economy is beyond dispute. However, based on experiences where it was substantiated that the movement of funds at the same time contains destructive elements, in what ways we manage and adjust the movement of funds are preconditions for maintaining the free trade structure. While national economies exist whose many stages of development differ, we must find conditions whereby these two sides of movement of funds can coexist. If not, we will return to the protectionism experienced in the 1930s. It is unfortunate that in the realm of WTO, there are already signs of protectionism; tax increases and unilateral sanctions taken by some countries.

2. Monetary imbalance = source of excess mobility of money

The financial problem of the global economy with which we are currently confronted derives from a large imbalance existing between the substantial (real) economy and financial mobility. This also means that excess mobility of money is prevailing. Funds that do not be linked to expansion of the substantial economy have often gone towards speculative acts in order to acquire short-term profits on currency, and products, etc., triggering economic breakdown. Financing, originally the lubricant oil for operating the economy smoothly, is conversely leading to failure of the economy.

The main reason for this excess mobility of money attributes to the discharge of the US's current balance deficit and its cumulation. The US's net foreign debt at the end of 1998 had reached 1.5 trillion dollars?Market Value? and its gross debt 7.4 trillion dollars?Market Value?, or 18.1 percent and 87.2 percent of nominal GDP, respectively. I would like to point out here that the 1998 US current deficit of about 3,500 million dollars is being carried up, therefore at the end of 1999 the US’s net foreign debt is estimated to be over 1.8 trillion dollars.

This current deficit of the US is being recycled in the capital account, but lest we forget that the capital account balance is the US's debt, nothing more, nothing less. In regard to deficit expansion, former commissioner Rubin announced that the US is not a Buyer of Last Resort, but this also means that it can not continue its debts indefinitely.

Added to this dollar’s excess mobility, Japan's extremely low-interest financing policy is serving as a source of funding that circulates around the globe. A situation is occurring that is similar to the one in which excess recycling of former oil money exacerbated Central and South America's debt problems.

3. Imbalance of people and commodities = shift from vertical specialization to horizontal specialization

An ecssessive supply of commodities is prevailing in the world. The substantial drop of the US dollar subsequent to the Plaza Agreement brought about major changes in its international competitive strength. As a reaction to the deterioration of competitive strength due to this US dollar depreciation, advanced countries constructed factories in ASEAN countries, China and the former East European bloc, where funding and land are cheap. Not only Japan, the US and Europe, but also Korea and Taiwan joined in this trend. This resulted in forcing elements of production in these cheap areas into international competition and causing a supply excess of people and land. The end of the Cold War facilitated the transfer of money and technology, and this accelerated the flow of investment.

It goes without saying that commodities produced at these new factories using new technology and the guidance of developed countries are relatively cheap, and withstand use in developed countries. The domestic factories in the investing countries, whose competitive strength deteriorated, have inevitably to be cut judging from the principle of competition. However, cutting back gives rise to the human problem of unemployment.

Unlike the US, where layoffs are commonplace, cutting back tends to be slow in Japan and Europe, and this is a major factor in the appearance of regional differences in economic recovery.

An excess of factories causes supply excess, and forms a situation that retards deflation internationally. On one hand, this is widening the scope of financial policies, but on the other, it is reducing investment profitability that takes into account a certain amount of inflation.

Making the situation more serious is the change from international vertical specialization to horizontal specialization. The merits of international specialization are brought about by the principles of comparative advantage. Looking back at post-war US-Japan trade friction, we have advanced from fibers and miscellaneous goods, to light electrical appliances, automobiles, semiconductors and communications technology. The relationship between Japan and Asia has also followed the same route. However, as trade frictions were repeatedly experienced, inferior industries has been reduced by cost increase; complementary relationships have been maintained; and they have expanded the global economy as a whole.

However, transfer of the latest technology is vigorous of late. In the background of this are the necessity of market expansion on the investing side and the raising of national consciousness on the receiving side. Moves to protect industries that have lost their competitive strength are without end: Japan once targeted domestic manufacturing from noodle to missiles, and the US protests for steel dumping of other countries. Even in this borderless age, national boundaries clearly exist for human issues, and these are dictating each country's politics.

Hand in hand with the insufficient cutting back of industries that have declined, international specialization is leveling out, and competitive rather than complementary relationships are intensifying. We are shifting from "complementary unity" to "substitutional rivalry".

4. Exchange rate instability = Rise of Euro and role of yen

At the same time that the US's accumulated foreign debt is a source of excess mobility of money, also making exchange rates unstable is something I described in my presentation here last year, so I do not wish to reiterate at this point.

The Euro appeared at the beginning of this year. It is a fact that the Euro still faces many problems, but we must not play down that Europe has also passed the Rubicon and formed ‘Euro Land’. In regard to the outflow destinations of Japanese funds, I have also already explained in Shanghai the situation where Euro is beginning to function as a substitute currency for the US dollar, albeit gradually, and expressed this as the new bi-metallism age. I would also like to point out here that not only with currency, but also in futures, options and other derivative transactions, Eurex transactions exceed CBOT.

The experience of old ‘gold and silver bi-metallism’ shows that rather than always leading to exchange rate stability, it is also likely to form elements that make exchange rates unstable. Nevertheless, this instability differs qualitatively from the instability that originates in the US dollar discharge, and we must thoroughly understand that the situation is completely different; Ethical order is expected for the national economies which provide key currencies.

Herein lies its principal role as a balancer of the world's largest foreign creditor nation currency, the yen. This is because Japan's selection of foreign currency application significantly influences the value of the US dollar and Euro. As a result of seeking exchange rate stability with the US dollar, Asian countries' lesson of US dollar pegging led to economic failure. The selection to replace this is surely a currency basket that reflects trade and direct investment performance, and the diversification of foreign currency reserves.

Cooperation with Asian countries including Japan and China will expand this function. Fortunately, with the exception of some countries, the Asian economy is in the process of extricating itself from its low point, and various options exist for cooperation.

First, diversity exists culturally and in stages of development in Asia; it can also advance a "rational investment sphere" open to the outside between countries able to cooperate; and countries with ample foreign currency reserves cooperating to reserve petroleum and food supplies is also an idea.

Second, it is because with only two currencies, hedge options will be limited. There is significant meaning to the existence of a third convertible currency ranking after the US dollar and Euro. It is not limited to the yen. We also hope that China's yuan will soon have full convertibility.

Third, use of the yen has the advantage of being able to finance trade and investment at low cost. It goes without saying that the interest rates of countries with surplus savings will always be lower than countries with insufficient savings. I would also like to add that preparations are underway for improved efficiency of the yen market and the stabilization of financing including the taxation system for that purpose.

5. The objective of dialogue between Japan, China and the US lies in what way to boost the relationship of mutual complementarity and construct a global Win-Win system. However in the current state, people, money and commodities exist in surplus, and rivalry rather than complementarity is likely to intensify.

The objective of IMF and WTO is to provide a common arena and reduce this rivalry in money, commodities and services. We hope for China's participation in the WTO at an early date.

The recent situation on the money front confirmed that treatment that considers differing stages of development and cultures is necessary. Considering this experience and the fact that shares in the global GNP and trade structures of participating countries are drastically changing, the rationalization and reorganization of IMF, the World Bank and also regional institutions are essential, for example quotas that reflect the principles and actual conditions of the 21st century.

A system to monitor the movement of funds for maintaining the free trade system is also important. On the side of developing countries, management of total amounts borrowed along with time limits is important. This is because short-term action is often taken in real terms for things classified as long-term capital statistically, for example national debt and stocks.

G7 published a statement concerning the international financial crisis at the end of October, but in regard to the monitoring the movement of funds, they are not necessarily in step. However, the market is now in a position of selecting key currencies as I have already discussed. Whether we become open and release the market information of participants as the US asserts, or whether we set direct regulations as Europe asserts, what is necessary for the G7 country is to carry out macro policies that eliminate excess mobility, which is caused by the imbalance of real economy and financing, and executes appropriate micro monitoring to maintain the soundness of individual financial organs.

Lastly, let me mention about the personnel issues. Even in this global age, national boundaries and regions exist in reality, and the movement of people is limited. Herein lie the barriers to globalization, and the sources of friction in international transactions. While the negative aspects of global capitalism are recognized, the purpose of Trilateral Forum is to cooperate with one another in order to maintain the free trade system, and to construct a new framework of international transactions for the 21st century. We can not achieve this by criticizing our international counterparts. It is also important to continue dialogue for this purpose, and to hold common values.

I would like to conclude my presentation by pointing out that ultimately, it is only when each country resolves the domestic problems it confronts by itself rather than pushing them outside, that the maintenance of a structure that contributes to expanding the global economy is possible.