a long *boring* read - but probably important.

  1. dub
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    If your curiousity clicked in on the heading, here 'tis:-


    Japan: The rapid run on dollar assets
    By Hussain Khan

    TOKYO - With the Nikkei stock average currently flirting with 11,000, up about 45 percent from its post-bubble 13-year low of 7,607.88 in April, it is starting to appear that a run on US dollar assets could well be causing the rise in Japanese stock markets.

    The yen has surged through the psychological barrier of 110:US$1, creating a sense of crisis as the run on dollar assets gains momentum. Japanese authorities are cautious about intervening heavily before Prime Minister Junichiro Koizumi reaches an understanding on the currency in his meeting with US President George W Bush on October 17-18 in Tokyo.

    According to one estimate, by Kyoto University Economics Professor Takamitsu Sawa, foreign investors have markedly improved the fundamentals of the Japanese economy by turning into huge net buyers of more than US$1.7 trillion in Japanese equities and assets and, by running away from their dollar positions, are thus generating a self-feeding cycle of further selling dollar assets and pushing up the Japanese markets even more.

    The flight of global investors from the dollar has serious implications, not only for the health of markets such as Japan's, but because of the peril to the US economy and thus the global economy as well, for which the United States has acted as economic engine and importer of last the resort. The US must take in $55 billion per day in investment in government paper and securities to fund the enormous deficits in its fiscal budget and its current account, the total balance of goods and services it trades with other countries. The current account deficit is expected to hit more than $540 billion in 2003, with the fiscal deficit trending towards $600 billion when off-budget liabilities are factored in.

    However, since the events of September 11, 2001, fiscal and military decisions by the administration of President George W Bush have raised concerns (see The end of American economic supremacy?, Sep 19) by both US fund managers and individual investors about the long-term health of the American economy. By diverting their investments outside the United States, these fund managers are corroborating a bleak long-term view of declining US economic strength, gradually running away from dollar assets to buy other assets or currencies like the euro, the yen and the yuan.

    The outgoing European Central Bank president, Wim Duisenberg, said last week that he was praying that what he called the unavoidable fall in the dollar would be gradual. The plunge has resulted not only in generating the pressures for the appreciation of these currencies but also in the rise of the gold price and rising capital inflows into China (see China's currency: Renminbi and ruin?, Sep 30), as well as the rising Japanese market.

    "The dollar is the currency of a country with a huge deficit on its balance of payments, close to 5 percent of its GDP [gross domestic product],"Duisenberg told reporters. "You can afford this one year, two years, maybe five years, but sometime there has to be an adjustment of its currency," he said. "We hope and pray that this adjustment, which is unavoidable, will be slow and gradual. We will do everything in our power to make it slow and gradual."

    Given the American deficits, other economists are also looking at the dollar as overvalued. As the American economy's weakness comes into focus, the dollar has to fall to reflect its real fundamentals. Therefore US Treasury Secretary John Snow welcomed a Group of Seven statement that currencies should be allowed to find their own level, calling it "a milestone change". His remark was against the backdrop of Japan's dramatic intervention in the forex market last year, equivalent to Ireland's entire GDP in an effort to keep the yen below 115 to the US dollar.

    The new cabinet upped its interventions after the G-7 meeting. Nonetheless, the currency has broken through the key 110 level. It is starting to appear that the yen's rise cannot be curbed, mainly because there is a widespread view in the market that the government and the Bank of Japan will not be able to intervene on a large scale in the face of US and Eurozone disapproval.

    "We will take the bullish yen by its horns when necessary," Finance Minister Sadakazu Tanigaki told a news conference after the currency had broken 110. His remark was widely interpreted to reflect the sense of crisis felt by the Japanese monetary authorities.

    But for foreign investors with dollar assets the sense of crisis is on the other side of the fence, ie, about fast depreciation in value. If that sense of crisis grows rapidly, prayers for a gradually falling dollar may be of no avail. The situation may degenerate into a rapid run on dollar assets and their conversion to yen assets, despite the Japanese government's precautions.

    "The yen could test 105 to the dollar over the short term," a Resona Bank official said, voicing a sentiment shared by many who believe that the US government will accept a weak dollar, as discontent grows among US manufacturers amid widening trade deficits.

    But a rapidly falling dollar means foreign buyers are more likely to bail out on US paper, putting the US in an economic trap. It will have to raise interest rates to entice foreign and domestic investors, which in turn would drive a stake through the nascent recovery from the three-year-old economic slowdown.

    Prior to the events of September 11, 2001, it could have been said of the current rally in Japan that there was no guarantee it would be any different from countless other failed comebacks, as a previous 18-month rise of 61 percent failed in 2000. But this time there is growing consensus that the current rally will continue. The main reason is that the falling dollar is being converted into yen in large quantities and entering the equities market. This has led the market to clear many obstacles that were hindering the economy's path toward sustainable growth.

    The bellwether Nikkei 225 peaked at its all-time high of 38,916 in December 1989. Like all bear markets, Japan's was not a steady decline. There were many rallies along the way. The market, however, has been following the path of US markets over the past three years, dropping about 63 percent at its worst point. Similarly the value of the Japanese market also fell, by more than 80 percent from its 1989 peak. It ultimately fell to its lowest level since November 1982, more than 20 years ago.

    During this period, the US government strictly maintained a strong dollar policy that led foreign investors back to dollar assets, selling yen assets at a substantial profit and thus bringing back the Japanese market to its new low. In addition to other factors and a weakening Japanese economy as nonperforming loans escalated, profit-taking by foreigner investors who then diverted the assets to a stronger dollar was a major cause of the rally's death.

    "In 1999, foreign investors' net purchases hit a record 9 trillion yen after the Nikkei average had fallen to the then post-bubble low of 13,842 at the end of 1998," according to Kyoto University's Suwa, writing in Japan Times. "In late March 2000, the average shot up to 20,337. Foreign investors then turned to profit-taking, posting net sales of 2 trillion yen in 2000. From April 2000, stock prices started tumbling until they hit the post-bubble low in April, 2003."

    But during the same period, the yen's value against the dollar rose to 110-112 from 119. The fluctuations provided substantial returns for foreign investors. It is a clear indication that the declining dollar was a major cause for sustaining the five-month-old rally.

    The major hurdle was the banks and their current account losses, their unrealized losses in shareholdings, the existence of large amounts of non-performing loans and their dwindling capital ratios. All these have been automatically cleared by the current rise in stock prices. Other companies have also improved their profit performance as a result of their banks' improved positions. The equity market's climb has also contributed to the growth rate of Japanese GDP and its overall economy during the last few months.

    This is not all gravy. The International Monetary Fund, in two wide-ranging economic reports delivered in September, called attention to endemic weaknesses in the Japanese economy, including mountains of nonperforming loans, dud companies and other problems (see Japan's promise - and problems, Sep 26). An economic recovery based on skyrocketing stock prices and exports to the United States, whose own recovery is anemic at best, is an economy in danger, especially if the yen rises to the point where it starts to cut into the competitiveness of Japanese exports.

    Nonetheless, economists are predicting GDP growth of about 2 percent this year, hardly exciting but double the anemic 1 percent growth over the past decade, which is contributing to the Nikkei's uptrend, along with the undervalued market. As many as half of Japan's listed companies have been trading at 50 percent of their book value.

    When the Nikkei for the first time crossed the psychological ceiling of 10,000, the then-finance minister, Masajuro Shiokawa, attributed the rise to improved corporate earnings. "A major reason behind it is the release of good corporate earnings results," he told reporters. "I think companies will compete with each other to release good earnings reports in the future, and this will lead to the vitality of the Japanese economy."

    Why the earnings improvement?

    "The benchmark Nikkei Stock Average closed out the fiscal first half above the 10,000 line on September 30, buoying both banks and life insurance companies and allaying fears about the health of the financial system," according to a report in Nihon Keizai Shimbun. "With the Nikkei average up nearly 30 percent from where it finished fiscal 2002 six months ago, the nation's seven major banking groups are now sitting on an unrealized gain of about 2 trillion yen in their share portfolios, up from an aggregate unrealized loss as of March 31. The stock market upturn has prompted a substantial improvement in the financial condition of life insurance companies as well."

    Market capitalization for companies trading on the first section of the Tokyo Stock Exchange was about 307.52 trillion yen, up 31.8 percent, or 74.15 trillion yen, from March 31.

    According to estimates by Dai-ichi Life Research Institute, the stock portfolios of the seven major banking groups swung from an unrealized loss of some 1.2 trillion yen as of March 31 to an unrealized gain of about 2.06 trillion yen. The unrealized gains will give the banks a financial cushion to clean up non-performing loans, opening up more breathing room for management to operate.

    The major banks' capital ratios are projected at 10-12 percent as of September 30, well above the regulatory minimum of 8 percent, in part because they no longer have unrealized stock portfolio losses to subtract from shareholder equity. The recent upturn in long-term interest rates is believed to have caused unrealized losses on bond-holdings of major banks to swell to 1.1 trillion yen. But the stock market gains will more than offset that paper loss.

    Except for Mitsui Trust Holdings Inc, the capital ratios at the major banking groups grew to 10 percent or higher. In the six months, the banking groups saw unrealized losses on their shareholdings disappear as the stock market moved higher, and they counted part of newly generated unrealized profits as capital. At Mitsui Trust, which holds a large amount of shares relative to its capital, the capital ratio rose by 1.5 percentage points.

    The capital ratios at Mitsubishi Tokyo Financial Group Inc and Sumitomo Trust & Banking Co improved to about 12 percent and more than 11.5 percent, respectively. It is quite clear in these reports that the unrealized losses on the shareholdings of banks and other companies disappeared as the stock market moved higher. Their capital ratios also went beyond the minimum requirement of 8 percent and an unrealized loss of 1.2 trillion yen as of March 31 turned into an unrealized gain of about 2.06 trillion yen.

    Given their improved financial position, the major banks thus have more room to lend and make revenue-enhancing investments in systems and financial product development. As a result, they should find it easier to achieve the profit growth goals laid out in the business improvement plans submitted to regulators.

    This was supposed to be the main hitch for which Koizumi and his minister for financial services, Heizo Takenaka, had been advocating banking reforms, and for which they had been struggling hard against the internal resistance of their Liberal Democratic Party. It was a God-given opportunity for them that the positive results as expected from their proposed banking reforms were automatically achieved to a great degree by the market's steep rise. Koizumi did not hide his jubilation. "I'll advance reforms to make that power visible and improve the real economy," he said.

    Earlier, he was in real jeopardy, as the Nikkei average was at 14,000 when he took office two and a half years ago. The first effect of his announced reforms was a further 50 percent market dive to 7,000 during his first two years in office. He is lucky enough that a descending dollar came to his rescue as a bolt from the blue.

    As an example of how corporate profits have improved and the had an effect on the larger stock market and economy, Mitsubishi Tokyo Financial Group Inc announced on September 30 that it now expects net profit of 270 billion yen for the fiscal first half ended September 30, up from the 70 billion yen projected in May. Reduced loan loss reserves and other factors resulted in an extraordinary profit of more than 220 billion yen. Mitsubishi Tokyo Financial also revised its full-year net profit projection from 190 billion yen to 380 billion yen.

    Of the extraordinary profit to be booked for the first half, the loan loss reserve reduction totaled some 170 billion yen. As ailing borrowers successfully restructure, some nonperforming loans have been upgraded to healthy, reducing the amount of necessary loan loss provisions.

    The group reported a core business profit of 325 billion yen, almost unchanged from the previous year. The net profit increase enabled the banking group to reduce by 250 billion yen the amount of deferred tax assets that are now counted as part of Tier 1 capital. As a result, the proportion of deferred tax assets in its core capital dropped from 41 percent to the 25-29 percent range.

    By the end of September, Mitsubishi Tokyo's overall nonperforming loans had decreased by 500-600 billion yen as newly generated non-performing loans fell significantly. The upgrading of loans has allowed corporate buyers to be upgraded to healthy as well, entitling them once again to credit facilities, not only from their banks but also from their suppliers, to improve their performance. Here lies the secret of their profits.

    Thus the rising stock prices have reduced non-performing loans and evaporated the banks' losses and their shareholdings in corporate borrowers - which in a kind of virtuous circle made the companies and the banks more attractive to buyers, kicking off a cycle originally generated by the sales of dollar assets, which now is starting to feed on itself to create a scenario for further dollar asset sales and diversion of currency flows to Japanese stocks.

    Japanese fund managers had no significant dollar assets to run to convert yen assets to save themselves from a declining dollar. Therefore they turned into net sellers to reduce their unrealized losses, on which they had been sitting for over a decade.

    Hussain Khan holds a master's degree in economics from Tokyo University and has worked in Japan as an equities analyst. He is an independent Tokyo-based analyst on current affairs and economic issues for various newspapers and magazines. E-mail: [email protected]

    (Copyright 2003 Asia Times Online Co, Ltd. All rights reserved)



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