In a complete policy turnaround, the United States yesterday sought to buoy Japan's collapsing currency and build a fire wall around the financial turmoil in Tokyo that has shaken stock markets worldwide.
The massive $2 billion intervention in currency markets, taken in concert with Japan, apparently vindicates a high-risk game of chicken by US officials. For days, they had resisted pleas from Beijing to London to join a multilateral effort to support the yen, holding out until they gained assurances that Tokyo will enact sweeping economic reforms.
In a phone conversation with President Clinton, Japanese Prime Minister Ryutaro Hashimoto pledged to speed efforts to pull Japan out of a recession. Yesterday was the first time since August 1995 that Washington sold dollars to shore up a foreign currency.
Previously, the US had rejected Tokyo's calls for currency-market intervention, saying such action would be ineffective without broad reforms at the bedrock of Japan's economy. But US support of the yen came yesterday "in the context of Japan's plans to strengthen its economy," US Treasury Secretary Robert Rubin said. If necessary, coordinated purchases of the yen will continue, he said.
The policy flip-flop underscores the US concern that a continued fall in the yen could further undermine the Tokyo stock market and rekindle the financial tumult that has crippled many East Asian economies.
Continued chaos in Tokyo markets - a plummeting currency and melting equities - intensified the risks of worldwide market instability and a global economic downturn. British Prime Minister Tony Blair this week said the eroding yen is the harshest threat to the world economy in two decades.
Deputy Treasury Secretary Lawrence Summers today plans to begin urgent talks in Tokyo, in which he is expected to nudge Japanese officials to quickly implement reforms. He and other members of a high-level US delegation will also attend a hastily called meeting Saturday of deputy finance ministers of the Group of Eight major industrialized nations, the Treasury Department says.
The Clinton administration believes an eroding yen, by making Japanese exports cheaper, would compel rival exporters to stage competing currency devaluations - thereby debilitating world financial markets.
Administration officials had expressed confidence the turmoil in Japan and much of East Asia would not drag down US equities and halt the economy's seven-year boom. But such confidence has recently frayed, as a 5 percent decline in the yen this month against the dollar has provoked a 2.6 percent slump on Wall Street and sharp corrections in other major world markets.
Washington has repeatedly emphasized that Tokyo cannot hope to revive its economy by devaluing the yen and whipping up exports. Rather, Japan must reshape its economy's bedrock: deregulate, cut taxes, and purge a banking system doubled over by hundreds of billions of dollars in bad debt, say US officials.
A Japan rebound is vital to a broad regional renewal, say US officials. Japan's economy is larger than East Asia's other economies combined, making it the region's prime source of capital and economic stimulus.
"We've been urging Tokyo for nearly two years to shake up their banking sector and reform, but the leadership still seems oblivious to how inaction can bring down East Asia along with their own economy," an administration official said on condition of anonymity.
The White House had said that shoring up the yen in international markets is a flimsy stopgap for profound change in Japan's economic structure. "Intervention [in currency markets] is a temporary tool, not a fundamental solution," Treasury Secretary Robert Rubin told the Senate Finance Committee last Thursday. Indeed, Tokyo last month bought more than $20 billion in yen in a failed effort to reverse the currency's decline.
Washington had left the yen alone so as not to be seen as supporting Tokyo initiatives such as growth-choking tax hikes and pork-barrel stimulus programs. The Clinton administration "is frustrated with the stupidity of some of the policy decisions made in Japan, and intervention in exchange markets would be an implicit endorsement," says Edward Lincoln, a senior fellow at the Brookings Institution here.
Finally, the administration had stayed on the sidelines in the currency markets because there is little domestic pressure to intervene. Although US industries that compete with Japan resent a weaker yen, consumers seem indifferent to the East Asia crisis.
Consumer spending in the US is rising at 4.5 percent this quarter after a 6.1 percent jump in the first quarter, or the fastest pace in 12 years, according to Merrill Lynch. The economic expansion is still strong, and the East Asia downturn has helped restrain inflation and interest rates.
Indeed, the consensus is that the Asia turmoil will not jump the Pacific. Abby Joseph Cohen, a leading stock-market guru and co-chairman of investment policy at Goldman Sachs, wrote in a report Monday that "the effect of Asian conditions on aggregate US economic growth [and] corporate profits is a moderate negative."
Until recently, Japan's leaders have also seemed unalarmed by their economy's problems. The faction-ridden governing party has advanced most reform efforts only under intense external pressure. A $113 billion stimulus package made up largely of public-works spending (but not yet implemented) has not improved the government's image. That move was overshadowed by a recent announcement that Japan's gross domestic product plunged in the first quarter by an annual rate of 5.3 percent.
Economic mismanagement and several corruption scandals have undermined the credibility of the ruling Liberal Democratic Party (LDP). Currency traders have, as usual, thrived on the political weakness, driving down the yen 45 percent in just three years.
"There is a dangerous lack of credibilty," says Edward Yardeni at Deutsche Morgan Grenfell in New York. "Even if the government does something that is good, the market won't believe it." Some analysts say the LDP might take bolder steps to energize the economy if it strengthens its hold on the legislature during elections on July 12.