It is a great honor for me to have this opportunity to present issues relating to today's theme "Roles played by the yen in the global and Asian financial and capital markets."

The purpose of my presentation is to facilitate discussion of currency problems including stable exchange rates, finance and investment, so that the U.S., China, and Japan, which all have fairly large positions in the world economy, can contribute to its steady growth without inflation. In other words, we will discuss possibilities of financial supply, which is necessary for each country's growth.

Incidentally, ASEAN countries are suffering from currency disturbances this year. It started in Thailand, then spread to neighboring areas and countries, even to Hong Kong and China, and also influenced South American currencies. First, I would like to address the causes of the currency disturbances in this area.

Second, I would like to analyze the current situation and problems in the international accounting system, which is led by the U. S. dollar. The currency disturbances in ASEAN countries originated from the gap between the floating currency system in major countries and the currency basket system used by many ASEAN countries. I will also refer to differences between Japan's post-war recovery and the development environment in China and ASEAN countries.

Third, taking into consideration the current situation and these problems, I will talk about the role of Japan and the yen in this area. This is the outline of my speech today.

2. Currency disturbances in ASEAN countries

ASEAN consists of countries which are in different stages of economic development. Singapore has been a part of NIES, Vietnam and Laos just joined ASEAN recently, and Cambodia has suspended its membership to ASEAN. Other areas and countries in the region include Hong Kong, Taiwan, Korea, and China. The currency disturbances occurred due to a number of problems unique in each country. However, let me take the case of Thailand and summarize the currency problems that are commonly seen in other countries as well.

The first common point is that many of these countries have set up a currency basket based on trading volume, etc., and have linked their currencies to the basket.

The direct causes of the Baht crisis were an export slowdown and an unstable financial system. However, the currency crisis occurred basically because the country was late in taking appropriate measures against changes in the overseas economic environment which is moving toward the era of "mega-competition," as well as being late responding to changes in the domestic economic restructuring that resulted from the country's advanced developmental stage. What symbolically illustrates this fact is that despite the rapid domestic and overseas changes, the government overestimated its past successes and continued to employ a kind of fixed-rate system based on the currency basket.

It is not necessarily always negative for Thailand and other developing countries to use a basket-linked rate. If the currency basket of relevant trading countries is well suited to the economic realities in the country, this method has an advantage of minimizing fluctuations in the exchange rate. The key is whether this basket rate is set at an appropriate level, and whether it can be adjusted flexibly in accordance with environmental changes.

A breakdown of the countries of Thailand's exports is as follows: U.S. 18%, Japan 17%, and Singapore 12%, with these top three accounting for nearly half of the country's exports. Details of Thailand's currency basket have not been announced publicly and are unknown. However, it is estimated that the weight of the U.S. dollar was 80% to 85%, causing a considerable gap between the currency and the actual trade weight. Although a basket system was employed, it was actually closer to a U. S. dollar-linked exchange rate system. This led to the following problem.

In order for a de facto dollar-linked rate to function, it is necessary for the competitive balance between Thailand and the U.S., the inflation rate, etc. to be well balanced. If these conditions are not met, the linked rate must be adjusted.

However, no adjustment was made in accordance with changes in each country’s environment, or it was adjusted too late. This produced a gap between the nominal exchange rate and the actual exchange rate, resulting in overvaluation of its own currency. The overvaluation of the currency caused a decline in international competitiveness, which adversely affected the current account balance.

Nevertheless, the basket system lasted for a while due to an influx of foreign money. The nation's capacity to borrow money for its economy has limits, however, just as an ordinary household does. Although the borrowing temporarily fills up the external imbalance, debt accumulates. Needless to say, the borrowing limit must always be managed with consideration for the ability to repay the debt.

The balance of external debt owed by private Thai companies expanded from U.S.$24.3 billion at the end of 1992 to U.S.$60.4 billion at the end of September, 1996. This is probably the result of the Thai government and private companies who are overconfident of the country's past rapid development. Various projects were planned on the assumption that the influx of overseas funds would last forever. One typical example is investment in real estate, which resulted in the current high vacancy rate in commercial buildings, a clear indicator of the gap between the plan and the reality.

The situation worsened when private companies borrowed money from abroad under the assumption that the basket rate would continue. In order to link two currencies which have a gap in fundamentals, the interest rate of the relatively weaker currency must be set high. As a result, private companies and financial institutions use U.S. dollars due to the low procurement cost. It is estimated that most of the dollars were sold without hedging for exchange rate risk. The selling position of U.S. dollars would create a vast currency-related loss for companies if the fixed basket rate were devalued, making it quite difficult to rebuild the macro-economy and reconstruct individual companies. This is probably one of the reasons why the government was late adjusting its rate.

The linkage with the U.S. dollar also deprives a country of the freedom to maintain an interest rate policy of its own, since it has no choice but to follow U.S. financial policies. This, together with the reversion to China, is one reason why the currency disturbance also spread to Hong Kong. We remember, under the Crawling Peg System, a lack of adjustment in the Peso exchange rate, and a transfer of short-term funds caused a crisis in Mexico. The recognized similarity to the Asian currency disturbance has brought on currency speculation in some of the South American countries.

In addition to these economic factors, another reason why governments in the region delayed making appropriate exchange rate adjustments was the political factor.

When Japan pushed up the value of the yen to 308 yen/dollar under the Smithsonian agreement from 360 yen/dollar under the IMF system it created serious anxiety among Japanese corporations.

This time, the currency was devalued, which can economically benefit companies by restoring international competitiveness. However, it cannot be denied that the government was reluctant to admit the failure of its past policies.

3. Problems in the international currency system

In addition to those internal reasons mentioned above, there are three other external factors which accelerated the currency disturbances related to the U.S.-dollar dominated currency baskets. Let me discuss these external factors, while comparing post-war Japan to the current situations in other Asian countries.

The first factor is the quality change in the U.S. dollar, which is still the de facto key currency. In other words, the country of the key currency has become a net debtor. After World War II, the U.S. dollar functioned as a value standard, supported by the absolute economic power of the U.S.. Also, an ounce of pure gold was pegged at U.S. $35, and foreign governments were given the right to change the Dollar' s balance to go at that rate. The IMF system was a gold-U.S. dollar standard exchange rate system. The IMF's fixed rate played an important role in Japan's post-war recovery. The fixed rate worked as a stable system with which to obtain foreign currencies, allowing resource-poor Japan to restore its economy.

On the other hand, the convertibility with gold kept the U.S. economy in order. Thanks to the sound economy of the U.S., Japan was able to use its current account balance as the criteria for its economic performance. When a deficit was recorded in the current account, Japan adopted a tighter financial and fiscal policy, and when a surplus was recorded, growth policies were employed.

However, along with the economic recovery of Japan and European countries, the role of the U.S. started to change. At the time of the "Nixon Shock" in August 1971, accumulating overseas debt forced the U.S. to lift the convertibility to gold, and it shifted to a floating system. At that time, the quality of the U.S. dollar became equivalent to that of the Japanese yen and the German mark.

Nevertheless, the U.S. dollar remained the most powerful international currency, due to the country's political leadership and military power during the Cold War, the lack of a replacement currency, the nation's relative advantages such as the size of the U.S. dollar market, as well as past inertia. This loosened the discipline of U.S. economic policies, and the U.S. turned into an international debtor in 1987. The main cause of the current exchange rate instability is that the currency of the largest debtor country is still used for international- settlements. This is also one of the major causes of currency instability in Asia.

In 1995, the yen-dollar rate reached 80 yen/dollar, the opposite story from the current situation. I consider this to have been the result of a combination effect of the cheap dollar, which was caused by the fact that the strong yen resulted from a trade surplus, in addition to the clear revelation of the extent of U. S. debt in the wake of Mexico's crisis.

The U.S. accumulated net debt is projected to reach $1 trillion at the end of this year. The vast size of the U.S. economy can still endure this enormous debt. However, it should be noted that the U.S. also has a structure, just like those of Mexico and in Asia, where insufficient domestic savings are covered by international borrowing, and the nation's total debt is further growing.

Second, another factor which accelerated the currency disturbances was the appreciation of the U.S. dollar and the cheap yen, which resulted from capital transfers. The exchange rate is eventually settled at a rate to appropriately reflect relative comparisons of fundamentals, such as each country's growth rate, unemployment rate, inflation rate, and current external balance. However, the exchange rate often fluctuates temporarily due to capital transfers caused by the gap in interest rates.

Since the U.S. economy is moving favorably at present, and because of the need to make up for insufficient domestic savings by utilizing non-residents’ capital, U.S. interest rates tend to be set higher than the inflation rate. Therefore, the actual interest rate in the U.S. is high. Capital transfers encouraged by high interest rates caused the current appreciation of the U.S. dollar and the cheap yen, despite the account balances of Japan and the U.S. Under these circumstances, ASEAN currencies, linked to U.S.-dollar dominated baskets, were further overvalued against the U.S. dollar, the Japanese yen and European currencies.

The third factor is competition among developing countries. Japan was able to concentrate on catching up with the U.S. It was after the Japanese income level increased substantially that Korea, Taiwan, and other NIES countries emerged as competitors. The average annual per capita income in Thailand and Malaysia is about U.S. $3, 000. With this income level, these countries must survive ever-intensifying competition with surrounding Asian countries, including China. Although the income level is fairly low yet with much room for improvement, compared with that of developed countries, these countries are also facing competition with even lower level countries. In this sense, the existence of highly populated countries such as China and India, the population of which would exceed China in the coming century, is significant.

Labor power is one production element but it involves people. Different from other production elements, transfer of labor across national borders has its limit even in this international era. In order to overcome this problem, other production elements that are relatively easy to transfer, such as capital or technologies, are moving across national borders and combining with labor and land in each local area. However, this results in discord between liberalization and the domestic economy (particularly unemployment problems) This issue clearly reminds us of the confrontation between the U.S. and Europe in the summit meeting held this year.

Needless to say, the principle of capital activities is the expected return on investment. It is not easy to withdraw direct investments, while movement of financial and securities investments can be abrupt. Invested countries should be aware of this and prepare appropriate measures.

Measures should be prepared in accordance with the developmental stage of each relevant country, and should not always be the same as those for developed countries. Each country has its own history, traditional culture, and national interest. The recent currency disturbances reminded us of the risk involved in liberalizing the capital account transactions more than the current account. Asian countries need to plan the liberalization of their capital accounts in accordance with each country's developmental stage and capacity.

4. Roles of Japan and the yen

I have analyzed the internal and external factors in Asian countries with regard to currency and finance, and have also pointed out that the U.S. has become a debtor country. In the post-war period, the U.S. functioned as an absorber of exports from Japan and Europe. However, it is difficult to expect the U.S. to function in the same way while the country runs current account deficits. Now is the time for Japan to make a contribution. Japan is the largest net creditor nation, although the amount of the surplus has shrunk somewhat, and it is the only country that can absorb exports of surrounding countries.

The amount of Japan's accumulated current account surplus matches that of the U.S.’ accumulated trade deficit. However, this balance is not necessarily favorable for both countries.

For Japan, where the aging of society is advancing, it is necessary to improve the infrastructure to secure a comfortable lifestyle while savings are still abundant. It is an urgent task for Japan to effectively utilize its savings to be used domestically. On the other hand, the debt-burdened U.S. economy is unstable, as proven by the quick reaction of the stock market to Prime Minister Hashimoto's speech at Columbia University, just after the summit.

The three roles of Japan and the yen can be mainly classified as follows.

First, needless to say, Japan is required to make a financial contribution to the currency crisis in Asia in cooperation with the IMF. Cooperation of regional central banks has already made a start on preventing a currency crisis, mainly by procuring funds in U.S. dollars. It is necessary to diversify the cooperation and add yen or other Asian currencies.

Second, and more importantly, Japan needs to expand its imports, in particular, absorb exports from other Asian countries. This will help exporting countries maintain their growth, while Japan, just like post-war U.S., can import cheaper products to increase the domestic purchasing power of people whose income cannot be expected to rise further as before. Due to the yen appreciation's affect on prices, the growth rate of imports exceeded that of exports, and the product import ratio exceeded 60%.

Another method is the income effect from a higher growth rate. It refers to investing Japanese savings in domestic projects, in particular the development of infrastructures. This does not mean expanding investments in public works, but rather utilizing private activities, including entries from overseas, and increasing capital efficiency.

Third, further internationalization of the Japanese yen is inevitable. Users of Japanese yen would then be able to utilize the lowest interest rates in the world, and could eliminate the exchange rate fluctuation risk from yen-denominated debts, such as ODA. Japan would also be able to avoid exchange rate fluctuation risk.

One purpose of implementing a single currency in Europe, the Euro, seems to be to minimize the fluctuation of U.S. dollar exchange rates. Australia already keeps foreign currency reserves in U.S. dollars, yen, and European currencies, evenly.

I am not suggesting that Asian currencies should all be linked with the yen. I consider it necessary to take trade and investment amounts into consideration when Asian countries set their yen weight or ratios for ASEAN currencies in their own currency baskets.

The purpose of my suggestion is not to eliminate the U.S. dollar, but rather to reduce the instability of the U.S. dollar by replacing the U.S.’ accumulated external debts. Since the U.S. gross debt is nearly $5 trillion, if it once started to flow out, it would have enormous destructive power, which could lead to a worldwide depression. Preventing such a scenario is the purpose of my suggestion.

Of course, there are some weak points in using multiple international currencies, when remembering the bimetallic experience of the past. However, it is difficult to produce one powerful key currency given the current state of the global economy. The country providing the international key currency must have sufficient centripetal force to support the centrifugal force of other countries which use the currency.

Since the end of World War II, the weight of the U.S. economy in the world economy has shrunk year by year along with the growth of Japan, European countries, and developing countries. In 1955, the U.S. had a 48.4% share, which is almost half of the global economy and is a sufficient centripetal force. This fact supported the IMF's U.S. dollar-gold standard. The U.S.’ share had fallen to 27.3% by 1990, and is projected to fall to 23.6% in 2010. This is the long-term background under which the dollar-yen rate has moved from 360 yen to the 110 yen level. One-fourth of the global economy cannot support the entire world economy. Under current situations, we cannot expect to have a single key currency. Reducing the current instability to the extent possible is today's task.

In this sense, Japan's best contribution to the world economy would be to expand its function as a buffer to absorb exports from other Asian countries, for which there is little or no time difference, as well as to increase the yen's international usage ratio. The currency disturbances in Asia can be considered an opportunity to do so.

Japan needs to reform its economy to further expand imports as well as undergo a Big Bang type reform in its financial and capital market, in order to make it easier to use the yen. The Hashimoto administration's goal of reform is in line with this purpose.

Japan's Big Bang is preparing substantial reformation plans towards 2001. Compared with the Big Bang in the U.K., Japan’s Big Bang will take place over a shorter period of time, and the areas for reform include not only the securities industry, but also finance and insurance concurrently. Therefore, the impact will be bigger than that of the original Big Bang in the U.K., so we could call it the "Bigger Bang." The first step is complete liberalization of exchange controls; relevant laws have already been drawn up and will be implemented from April 1 next year. This liberalization promotes various reforms in Japan by exposing the Japanese market to overseas markets and by letting them compete according to the market principle. Some effects are already visible in various fields in advance of the liberalization. One example is the renewed entry increase of foreign financial institutions into Japan and related personnel transfers.

Finally, I would like to emphasize once again that current account deficits can be filled up temporarily by borrowings. However, it is a debt, and it needs to be repaid. Even in an era of internationalization and regionalization, each country must take responsibility for their own economic problems and resolve them with their own methods.

Thank you very much.