Download Euro and Yen vis-à-vis the Dollar in the Global Economy

EURO AND YEN VIS-À-VIS THE DOLLAR IN THE GLOBAL ECONOMY
Peter Bofinger, Universität Würzburg∗
Introductory Statement given at the Panel Discussion
“The Euro’s Performance - the Yen’s Perspective”
organised by the Japanese-German Center Berlin
on 24 May 2000 in Berlin
It is a great honour and pleasure to chair this panel discussion. I will start with a short introduction on the triangular relationship between the three key currencies of the world economy.
In my view, it is very useful that the organisers have focused on the yen’s perspective. As we
have already seen, this perspective allows to gain specific insights into the actual currency
problems that are not so present from a German or European view.
The first important insight concerns the depreciation of the Euro. Today, it is almost common
knowledge in Europe, that the so-called weak Euro is due to fundamental structural problems of
the Euro area’s economy. While this could make some sense in relation to the dollar, the
proposition becomes almost absurd if it is applied to the yen-Euro rate. In this context all the
factors that could have some impact on the exchange rate clearly favour the Euro:
•
The structural problems of the Japanese economy are clearly more severe than those of the
Euro area.
•
As far as GDP growth, interest rates and the financial situation of public sector are
concerned, they would all call for a major appreciation of the Euro vis-à-vis the yen.
Nevertheless, the Euro has depreciated vis-à-vis the yen more or less in same way as it did vis-àvis the dollar. The lesson that can be drawn from the yen perspective is obvious: Fundamental
factors have no systematic impact on floating exchange rates. Or in other words, all the standard
explanations for the weak Euro are completely ad-hoc and lack a sound theoretical basis. In
introductory courses our students learn the important principle of falsification which was put
forward by Karl Popper. In the present discussion on exchange rates nobody seems to feel
embarrassed that the theoretical explanation that is presented for one case, the Euro-dollar rate, is
∗
Homepage: http://www.geldpolitik-online.de
already falsified by the second case, the yen-Euro rate. Astonishingly there also many of my
academic colleagues who disregard such fundamental principles of scientific research.
The implications for the global economic order are very serious. What we are used to call an
international monetary system is a mechanism that generates exchange rate paths that are more
or less random.
The second insight from the Japanese perspective is that costs of such erratic exchange rate
movements are immense. How did it come that Japan, the most dynamic OECD economy of the
1970s and 1980s has entered such a long period of economic stagnation. If “structural problems”
are the main reason, how is this compatible with the success story of ten and twenty years ago? If
it was the asset bubble of 1989, how could it paralyse Japan for more than a decade? In my view,
the explanation is different. All the problems began with an unprecedented appreciation of the
yen in the first half of the 1990s. In order to cope with such a shock and to maintain their market
shares, companies have to reduce their profit margins. Of course, a large exchange rate shock
means a large decline in profit margins of enterprises which then also affects the balance sheets
of the banking system. In the second half of the 1990s the yen-dollar exchange rate depreciated
somewhat but it became even more volatile. Thus, it is not surprising that today Japanese
companies are extremely hesitant to invest in Japan and that non-residential investment is the
weakest component of the Japanese GDP. Who knows today where the exchange rate will be, if
a new plant can start its operations in two or three years? Will it be 140 yen per dollar, 100 or
only 60? Thus, the second main insight from the Japanese perspective is that exchange misalignments and exchange rate volatility create high costs for national economy and also for the world
economy. So far, the costs of the Euro-dollar misalignment have not yet materialised. But there
is no doubt that the huge and growing US current account deficit is a major threat for global
economic stability.
This leads to the third lesson that can be drawn from the Japanese experience. It is often heard
that central banks are unable to stabilise exchange rates against market pressure. The yen-dollar
market provides an instructive case-study for that proposition. From March 1999 to March 2000
the foreign exchange reserves of Japan increased by about 40 % or $ 85 billion. Thus, obviously
there has been a very intensive intervention activity. Was it successful? My answer is yes. In the
last few months the Japanese authorities had been able to prevent a decline of the dollar below
the psychologically important 100 Yen threshold. An interesting side-effect of these inter-
ventions is that they are very profitable. The Bank of Japan buys dollar assets with an interest
rate of now 6.5 % and exchanges them against yen assets with a zero interest rate. Unfortunately,
the Japanese authorities lack the courage to announce an official floor for the yen-dollar which
would certainly improve the investment conditions in Japan.
The lesson for the triangular relationship yen-dollar-Euro is clear:
•
The big three should stabilise exchange rates if misalignments become excessive.
•
They can do this even against strong market pressure if they really want it. The recipe for
success is that the central bank with strong currency is taking the lead.
In the case of the Euro-dollar relation the policy implication is that interventions to stabilise the
Euro would be successful but they require that the main burden of interventions is borne by the
United States1
1
There historical examples for such a co-operation: Carter bonds in 1978 and the Louvre accord
in 1987 were joint efforts to stabilise the dollar.