Japan's $1 trillion to the rescue?

Can Japan, the world's second largest economy, save the global financial system?

Don't count on it.

As world leaders prepare to meet in Washington Saturday to seek a way out of the financial crisis, some are casting covetous eyes in the direction of Japan's $1 trillion worth of foreign reserves as a source of salvation for troubled nations and banks.

In Tokyo, too, a group of parliamentarians from the ruling Liberal Democratic Party (LDP) are pressing the government to spend some of its reserves – the second largest in the world – to win international prestige and diplomatic influence.

They are likely to be disappointed. The Japanese authorities say that while they are willing to lend some money to the International Monetary Fund (IMF), they would be happier offering advice born of their own financial crisis a decade ago than a lot of cold cash to today's victims.

And though Japan's financial system is weathering the crisis better than many other rich countries, a property slump and falling exports are likely to throw the economy – already heavily burdened by debt – into a recession, denting Tokyo's ability to lead the world out of the current turmoil.

The Organization for Economic Cooperation and Development (OECD) predicted Thursday that Japan's economy would shrink 0.1 percent next year, not much better than the average for its members – a 0.3 percent contraction. The US economy is expected to shrink by as much as 0.9 percent.

"We can use our reserves only to buy and sell foreign exchange to stabilize the yen," explains a senior Finance Ministry official who asked to remain anonymous. "We can't use them for anything else."

That caution frustrates Kotaro Tamura, a young Turk in the LDP and former investment banker, who sees the financial crisis as "a huge opportunity for Japan."

"Cash is king right now, and we have a huge cash pile" he points out. "We should invest in Korea and the US, help rescue them, and we would get economic and diplomatic returns."

His enthusiasm for more creative ways of using the reserves has won a certain amount of support in financial circles. "Japan has big foreign reserves and it is worth considering how to spend them," says Hiromichi Shirakawa, Credit Suisse chief economist for Japan. "The money could finance more effective measures to underpin the international financial system."

Government officials, however, insist that Japan's reserves, 85 percent of which are invested in US Treasury bills, are not just sitting ready to be spent.

The dollars were amassed, they point out, when the Bank of Japan was intervening heavily in the foreign exchange market a few years ago to stop the yen from rising in value, which would have hurt exports.

The government raised the money to buy those dollars by issuing yen-denominated bonds, so the foreign reserves in dollars – an asset – are balanced by an equivalent yen debt – a liability.

This makes the Finance Ministry reluctant to use the reserves in potentially risky investments, such as saving Iceland or propping up troubled US banks in return for equity.

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