You are missing the key effects due perhaps to your US-centered perspective which comes with a certain degree of complacency that the Japanese are hostage to the U.S. economy. By selling US Treasuries, the Japanese will push up US interest rates and cause dollar denominated assets to fall in price and the trade weighted value of the dollar to rise. The rise of the dollar will increase imports and help the Asian exporters. The fall of dollar-denominated asset prices will at the same time attract global capital to prevent a free fall of the over-valued equity market after a significant but manageable correction. A new global equilibrium of asset prices will find a stabilized level. True, US GDP growth will fall back to less than 2% from its current abnormal high, but 2% is rather normal historically for the U.S. Global merger prospects will favor US firms more because of the rising dollar. The key lies in the speed of the Japanese withdrawal which will be governed by Japanese self interest in not pushing US Treasuries into a sudden deep dive, but to orchestrate a gradual fall. While short-term fundamentals favor the US dollar, long term fundamentals are increasingly and undeniably negative. U.S. trade and current account deficits reached US$250 billion in 1998 and may reach $300 billion in 1999. Net debtor position of the U.S. is around US$1.9 trillion. Whenever foreign-held dollar reserves are sold, an equivalent of U.S. owned assets are liquidated immediately at market price. If the amount sold is large enough, it will cause a recession or even depression in the U.S., as in 1929-32, which the post-war Bretton Woods system of fixed exchange rates was designed to prevent from occurring again. In 1995, after the Federal Reserve started to hike interest rates in 1994 and sharply curtailed its own purchase of Treasury bills, triggering the Mexico peso crisis and a subsequent U.S. slowdown, the Bank of Japan initiated a program to buy $100 billion of US treasuries. China bought $80 billion. Hong Kong and Singapore bought $22 billion each. Korea, Malaysia, Thailand, Indonesia and the Philippines bought $30 billion. The Asian purchase totaled $260 billion from 1994 to 1997, the entire increase in foreign-held U.S. dollar reserves. These recycled dollars pushed up stock prices in America. After 1997, flight capital from Asian has played a significant role in the rising US equity markets. A sharp correction of the stock market accompanied by an abrupt slowdown of the US economy is a matter of when and not if. Also, the new euro will pose a direct challenge to the US dollar as the preferred currency for international trade. The financial world is in the process of shifting from a dollar-centered system to a bipolar dollar-euro system. The Japanese would like to make it a tri-polar system. Just like the post-war corrections in U.S. markets in 1971-73, 1978-79, 1985-87, which critically stalled the U.S. economy because the contributing currency overvaluations were permitted to go too far and for too long, the next correction will have equally severe economic consequences if the dollar stay high to long. There are no pure winning moves for any single party any more in this globalized economy. It is to everyone's interest to moderate the rate of change and allow the necessary long term structural readjustments to take place with minimum damage. That is the one lesson we all can learn from the events of the past 20 months. The technology of the finance system now permits lightning speed that can be extremely destructive. It is up to government policies to slow it down while allowing the readjustments to happen gradually and relatively benignly. Henry C.K. liu Brad De Long wrote: > >http://www.afr.com.au/content/990308/world/wtokyo.html > > > >"Kenichi Ohmae . . . believes Japan is being > >'micro-managed' by the United States. > > > >"In particular, he says it is being run by the 'Committee of > >Three' - Federal Treasury heads Robert Rubin and Larry > >Summers and Federal Reserve chairman Alan > >Greenspan. > > > >"Their motives, according to Ohmae, are not so much to > >keep Japan under the thumb as to provide a constant diet > >of alternative resuscitation measures - such as quantitative > >easing in monetary policy - so Japan won't be tempted to > >do what it actually needs to do to revitalise: liquidate > >assets, including holdings of US treasury bonds." > > Hmmm. Liquidating U.S. Treasury bonds means that the price of Treasury > bonds and other denominated assets relative to yen assets falls, which > means that the yen rises, which means that U.S. demand for Japanese > products falls. > > This means that (with the U.S. no longer serving as the importer of last > resort) Japan falls deeper into recession. > > Am I missing something? What's the alternative theory by which raising your > exchange rate expands your economy? > > Brad DeLong
