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.
"There is no imagination" for such a venture, says Teizo Taya, a former senior Bank of Japan official who now teaches at Rikkyo University in Tokyo. "This government does not think of itself as a hedge fund." [Editor's note: The original version misspelled the name of the university.]
Lending to the IMF, however, as it seeks more funds with which to bail out struggling economies, fits Japan's ambitions better: Japan is set to offer the IMF as much as $100 billion in foreign reserves, Reuters cited a government source as saying.
"We see lending to the IMF as basically risk-free," Finance Minister Shoichi Nakagawa said recently.
Another benefit of such loans is that Japan's money would remain in US dollars, so there would be no need to sell US treasury bills; large sales of those bonds would have a negative effect on the value of the US dollar.
"The Japanese government is still very sensitive to this," says Mr. Shirakawa. "They think they need to support the US and the dollar for national security reasons" in order not to endanger the US security umbrella in the Pacific under which Japan has sheltered for the past half century.
That line of thinking also means that in the coming debate over the need for reforms in the international financial system, Tokyo will resist proposals that cast doubt on the centrality of the US dollar, he adds. "Japan would be the last country to drop support for the dollar," Shirakawa says.
"The US dollar is the currency of Asia," adds Martin Schulz, an economist at the Fujitsu Research Institute in Tokyo. "You don't upset your central banker. "It is a no-no in Japanese politics to offend the United States. No one would dare think about it."
Instead, he predicts, the Japanese government will join any international initiative that the Group of 20 might agree on and contribute funds to it, "but they won't be the ones drafting significant plans or putting numbers to them."
Officials here say their greatest contribution to resolving the financial crisis will be to remind other nations of the lessons Japan learned from the Asian financial crisis a decade ago.
They were reflected, the Finance Ministry official says, in the principles espoused last month by the G-7 finance ministers when they agreed to take urgent steps to unfreeze credit markets, ensure banks have ready cash to lend, and reassure private depositors their money is safe.
"We have been insisting on these three points," the official says. "It took us time to implement them" 10 years ago "and we know from the past, the faster the better."
The speed with which the US and European authorities intervened to shore up the financial situation last month, he adds, shows that "in a philosophical sense, Japan took a leadership role."
Mr. Tamura, however, would like a bit more visibility for that role. "It's an emergency now, so it's a favorable situation for Japan to build up some kind of international leadership" while making long-term profit from successful foreign investments, he argues.
"But bureaucrats don't want to risk failure," he laments.