The Internationalization of the Yen

Although the Japanese yen is increasingly being used in international transactions, its use is still rather modest compared to the US dollar and the deutsche mark. Why? George S. Tavlas and Yuzuru Ozeki

Japan's phenomenal economic success as J The rationale behind these views is appar- tal from the rest of the world, also in terms of the world's largest net creditor nation in re- ently convincing. During 1983-89, Japan's cu- sterling and the US dollar. The willingness of cent years has provoked increasing demands mulative current account surplus amounted foreigners to hold liquid liabilities denomi- that it accept broader international responsi- to about $415 billion, making that nation the nated in sterling and the US dollar allowed bility. Thoughts have turned to the possibil- world's largest net international supplier of those currencies to serve as international cur- ity of a tripolar international monetary sys- capital. Japan's net long-term capital outflows rencies, enhancing the liquidity of the interna- tem, centered on the US dollar, the deutsche totaled about $620 billion, or some $205 bil- tional monetary system. mark, and the Japanese yen. In such a system, lion more than the cumulative current ac- But contrary to the growing expectations other countries' currencies would be pegged count surplus (see chart). The balance has of the role for the yen in the international to one of these three, and the three "core" cur- been financed mostly by monetary system, the impli- rencies would float against each other. If this short-term capital inflows. cations for the yen's use in occurs, it would represent a substantial modi- This situation, whereby international transactions fication of the international monetary system. Japan has emerged as a net are mixed. Despite Japan's In this connection, some have suggested that supplier of long-term capi- emergence as the world's a yen zone is emerging in Southeast Asia, tal and a net borrower of largest net creditor nation, whereby the increased use of the yen in Asian short-term capital, is analo- its capital outflows have regional trade and financial transactions will gous in some respects to the not significantly facilitated contribute to its use as an anchor currency. position of British banks in the yen's internationaliza- Eventually, it is suggested, the outcome could the late 19th and early 20th tion because capital flows be an Asian monetary union, with the yen centuries and to that of US (both short-term and long- serving a similar function to that of the banks in the post-World term) have been primarily deutsche mark in the European Monetary War n period. During those denominated in currencies System. earlier episodes, British and other than the yen. The evi- US banks served as bankers dence suggests that the A longer discussion on this topic, by the authors, to the world, exporting share of international trade IMF Working Paper (WP/91/2) entitled "The long-term capital denomi- transactions denominated Japanese Yen as an International Currency," is nated in sterling and the US in yen is much smaller than available from IMF Publication Services, dollar, respectively, and the currencies of other large Washington, DC 20431, USA. borrowing short-term capi- industrial countries. Fur-

2 Finance & Development /June 1991

©International Monetary Fund. Not for Redistribution ther, although there appears to be a relatively power. Moreover, during the 1980s, Japan ing short-term claims (i.e., supply short-term wider use of the yen as a regional currency in recorded lower consumer price inflation (at capital) in the currency of a particular coun- Asia, a yen-zone does not appear to be emerg- 2.5 percent per annum) than the other large try, it implies that the country possesses a ing. This article explains why this has hap- industrial countries. In addition, Japan regis- large supply of short-term, relatively high- pened, briefly discussing the necessary condi- tered the third lowest level of inflation vari- yielding financial instruments denominated tions underlying the international use of a ability; at 2.2 percent, it was only slightly in its own currency, the access to such instru- currency and the role of Japan as an interna- above that of Switzerland (1.8 percent) and ments is relatively free from controls, and for- tional financial intermediary. Germany (2.1 percent). In recent years, Japan eigners attach a relatively high degree of cer- has carried through a number of measures to tainty to that nation's currency. Foreigners International currency use broaden its financial markets and to ease ac- may demand short-term claims denominated The uses of a currency in the international cess to those markets by foreigners. Finally, in such a currency in part for liquidity and in- monetary system are analogous to, albeit during the 1980s, Japan's share of world ex- vestment, or to pay for imports denominated more complex than, those of a national cur- ports rose by 21/2 percentage points (reaching in that currency. The nation's ability to at- rency serving as a unit of account, means of over 9 percent by the end of the decade), a tract short-term capital enhances its capacity payment, and store of value (see "Interna- larger increase than any other major indus- to supply longer-term loans denominated in tional Currencies: The Rise of the Deutsche trial nation. Moreover, the direction of the nation's currency to the rest of the world. Mark" by George Tavlas, Finance & Develop- Japanese trade moved progressively toward If the nation meets these conditions, it can ment, September 1990). But whereas money is Asian developing countries, paving the way function as an international financial interme- determined by government fiat in the domes- for a larger regional use of the yen. diary (i.e., a world banker). In conjunction tic context, the choice of currencies to be used But certain problems remain. Despite re- with its role as a world banker, the growth of for international transactions is predomi- cent efforts to liberalize Japanese financial a nation's liquid liabilities can exceed that of nantly the result of market-determined pro- markets, some areas are still subject to re- its official reserves. As Charles Kindleberger cesses. A major benefit is provided to a coun- strictions. For example, the Treasury bill and Peter Lindert noted with respect to the fi- try whose currency becomes international. market is not very active, the commercial pa- nancial intermediary role of the United States The issuing country derives seigniorage be- per market is not yet well developed, restric- in the 1950s, the nation's liquid liabilities cause the foreign claims built on it are denom- tions on some euro-yen investments remain, were growing faster than its reserves, but it inated in its own currency. The country can, and trading in the government repurchases also had "such extensive longer-term, less liq- therefore, inflate away a portion of its nomi- market is complex. Further, a number of fac- uid, assets abroad that the nation was a nal debt. tors have inhibited the yen's use in interna- heavy net creditor to the rest of the world Several factors are necessary for a cur- tional trade, including: (1) Japan's share of ex- overall .... [Thus] the United States was rency to be used internationally: ports to developed countries (particularly the acting as a financial intermediary, lending • As explained by Robert Mundell: "It is a United States) has increased and is likely to long and borrowing short" (International fact of historical tradition that the top cur- be denominated in these countries' own cur- Economics, Homewood, Illinois, 1978). rencies; (2) Japanese exporters apparently rency is provided by the top power" Japan as world banker ("International Monetary Options," The Cato have sought to denominate their trade in for- Journal, Spring 1983, page 189). eign currencies, while absorbing reduced Japan's role in the global allocation of • There needs to be confidence in the value profit margins during periods when the yen capital flows has increased markedly in re- of a currency and, therefore, in the issuing na- has been appreciating against those curren- cent years, reflecting both its current account tion's inflation performance. High and vari- cies, so as to maintain their market share. surplus—the counterpart for the nation's ex- able inflation generates nominal exchange (When the currency of an exporting nation cess of saving over domestic investment— rate depreciation and uncertainty. appreciates, its exports sales typically fall, be- and its emergence as an international finan- • The country should have deep, open, cause the appreciation raises prices in terms cial intermediary. In 1985, Japan became the and broad domestic financial markets. For ex- of the importing nation's currency. Japanese world's largest holder of net external assets. ample, a well-developed bankers' acceptance exporters, however, have often kept the for- Moreover, by the end of 1989, Japanese resi- market contributes to the amount of trade fi- eign currency price of their exports un- dents had accumulated net external assets of nanced in a currency, and thus, to trade in- changed, maintaining their sales level, but re- more than $290 billion, up from an average of voicing in that currency. Correspondingly, ac- ducing their profits.); (3) the absolute level of about $30 billion in the first half of the tive short-term (e.g., Treasury bill and Japanese exports to non-Asian developing decade. Almost 60 percent of Japan's foreign commercial paper) markets contribute to the countries fell during the 1980s, impeding the claims were long-term, while over 60 percent international demand for currencies, reflect- yen's use in trade, since developing countries of the nation's liabilities were on the balance ing central banks' and other investors' tend to denominate their imports in foreign sheets of its banks and were short-term. preferences for liquid and safe financial currencies; and (4) the bankers' acceptance Also—in line with the Kindleberger-Lindert instruments. market is not well-developed, making it diffi- view—the ratio of Japan's short-term liabili- • The larger a nation's share of world ex- cult for Japanese firms to obtain trade financ- ties to official reserves rose sharply during ports, and the greater the extent to which those ing in yen, hence curtailing the yen's use as the course of the decade. exports are denominated in the exporter's cur- an international unit of account and medium But has Japan's international intermediary rency, the greater the demand for that cur- of exchange. function contributed to the willingness of for- rency by foreigners in order to pay for imports. The pattern of a nation's capital flows eigners to hold liquid liabilities denominated How has Japan performed on the basis of shows how international currencies emerge, in yen? Not really. In contrast to the earlier the above criteria? Japan's strong economic given the existence of the necessary condi- cases of the United Kingdom and the United performance has allowed the nation to re- tions for international currency use described States, which borrowed short-term and lent emerge as a world economic and political above. For example, if foreigners are acquir- long-term primarily in their own currencies,

Finance & Development /June 1991 3

©International Monetary Fund. Not for Redistribution commercial banks in Japan have been in- banks to also borrow in foreign currencies. volved chiefly in maturity transformation of Table 1 Although Japan has been channeling funds external funds—that is, borrowing short-term Yen denomination to the rest of the world, that process has not funds overseas in foreign currencies (mostly of Japanese foreign necessarily been conducive to the yen's inter- US dollars) and investing funds in long-term trade, by region national use. Since foreigners have not been instruments overseas denominated in foreign (in percent of total) accumulating yen-denominated loans, they currencies. Because the regulated Japanese fi- have had relatively little incentive to accumu- nancial market to some extent limited the rate 1983 1987 1989 late yen-denominated claims to pay back such of return on financial instruments (relative to Exports loans. Further, the fact that the Japanese fi- rates available in some other financial cen- All regions 40.5 347 34.7 nancial market has been (until recently) ters), Japanese financial institutions have North America 14.0 16.8 16.4 tightly regulated, and remains narrow and sought to invest substantial funds in other in- Western Europe 51.0 53.1 42.2 thin in some areas, has also discouraged the dustrial countries in nonyen denominated in- Southeast Asia 48.0 36.3 43.5 holding of short-term, yen-denominated struments; in the late 1980s, about 75 percent West Asia 52.0 36,3 claims by foreigners. Latin America 31.6 of Japanese net long-term capital outflows 1 Africa were directed to industrial countries. 58.4 The yen's use ... Japanese banks, as well as some nonfinan- Imports As an invoicing currency in trade. cial corporations, have capitalized on their All regions 3.0 11.6 14.1 Recent data trends confirm the expectation good credit standings in the international cap- North America 5.0 9.4 10.2 that the yen's use as an international cur- ital market, borrowing short-term funds to ac- Western Europe 13.0 27.1 27.7 rency, although increasing, is still rather mod- quire long-term bonds overseas. Although ex- Southeast Asia 2.0 13.9 19.5 est. The proportion of Japan's exports denom- ternal lending by Japanese banks increased West Asia 1.3 1.5 inated in yen rose from 17.5 percent in 1975 to Latin America 8.4 8.3 during the 1980s, the share of yen-denomi- 1 40 percent in 1983, before declining to about Africa 2.3 10.9 nated lending—though rising—remained less 35 percent in the second half of the 1980s. By Source: Japanese Ministry of Finance. than one third of the total throughout the 'Exduding the Republic of South Africa. contrast, about 96 percent of US exports are decade. Further, direct investment to develop- denominated in US dollars, while national ing countries comprises less than 5 percent of currency invoicing of exports by the major Japan's net capital outflows, and most of that European countries is in the range of 40-80 has been directed toward Asian developing yen. Consequently, banks often borrow short percent (with Germany having the highest countries. Thus, the processes underlying the term to make "impact loans" (foreign cur- proportion). The share of Japanese imports emergence of sterling and the dollar as inter- rency loans to domestic firms) to finance denominated in yen rose steadily, from less national currencies, whereby developing (and trade. Second, such borrowing possesses sev- than one percent in 1975 to about 14 percent reconstructing) countries accumulated ster- eral advantages over yen-denominated bor- in 1989, but was still well below the propor- ling- and dollar-denominated balances (for rowing in Japan. For example, the reserve re- tion of imports invoiced in the local curren- liquidity and investment, to pay for imports quirement on all foreign-currency liabilities to cies of the United States (85 percent) and the invoiced in those currencies, and to service nonresidents, regardless of duration or size, is major European countries (27 percent to 52 loans for capital development denominated in lower than reserve requirements applicable to percent) at the end of the 1980s. those currencies), appear to be less significant yen-denominated deposits and, unlike rates In regional trade transactions. Yen- in the case of the yen (except in the case of paid on other types of deposits, which are of- invoicing of exports to Southeast Asia de- Asian developing countries). ten regulated, interest rates on foreign cur- clined over 1983-89 (see Table 1), but yen-in- Since Japanese banks lend largely in for- rency deposits are set freely by the market. voicing of imports from Southeast Asia rose eign currencies to take advantage of higher Third, the existence of prudential regulations sharply. Nevertheless, the proportion of im- yields abroad, why do the banks also borrow limit banks' net foreign exchange exposure. ports invoiced in yen (at 20 percent) from primarily in foreign currencies? One reason, Specifically, banks' combined net foreign ex- Southeast Asia does not suggest that a key noted earlier, is the absence of a well-devel- change exposure cannot exceed a narrow regional role is emerging for the yen in Asian oped bankers' acceptance market and the fact limit (positive or negative) at the close of each trade transactions. that both exports and imports are predomi- business day. Thus, if banks lend in foreign As a medium of exchange. Turning to nantly denominated in currencies other than currencies, prudential regulations prompt the the use of the yen in international financial markets, the yen's share of external bank loans rose sharply until 1985, reaching 18.5 percent, but subsequently declined to 5.5 per- George S. Tavlas Yuztiru Ozeki cent—about the same as its share during the a US citizen, is a Senior a Japanese citizen, is an Economist in the IMF's Economist in the IMF's first part of the 1980s. Regarding external Treasurer's Department. Treasurer's Department. bond issues, the share of the yen rose from He holds a PhD from New From 1982 to 1984, he less than 6 percent in the first part of the York University, and has worked for the Japanese 1980s to over 8 percent in the second half of worked at the US Ministry of Finance on ex- the decade (although the yen's share declined Department of State and ternal assignment from the in 1988 and in 1989). Finally, the share of the the OECD. IMF. He holds a PhD from yen in the denomination of eurocurrency de- the University of Hawaii. posits rose from under 2 percent in the early 1980s to 5.5 percent in 1989. Since 1987, the yen's share of each of these three interna-

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©International Monetary Fund. Not for Redistribution about 5 percent in yen. Thus, the data indicate Table 2 that the yen's regional use by official agents, Official holdings of foreign exchange, 198O—89* though growing, is considerably less than the (In percent) use by official agents of the deutsche mark within Europe. ion 1S33 man 1963 Conclusion Japanese yen The yen's emergence as an essential All countries 4.4 5.0 7.9 7.9 Selected Asian countries 13.9 15.5 22.8 17.5 component of the international monetary system is directly related to its role as a key cur- US dollar rency within Asia. Although the yen's use as All countries 68.6 71.4 67.1 60.2 a regional Asian currency has increased in re- Selected Asian countries 55.7 48.4 48.6 56.4 cent years, the data pertaining to both Japan's Deutsche mark trade invoicing and to official currency hold- All countries 14.9 11.8 14.6 19.3 ing by Asian countries indicate that a yen- Selected Asian countries 20.6 16.7 16.7 15.2 zone does not appear to be emerging. Whether oources: IMI- finnuai Hapon. 1390. ano stan eslimales. 1 Enfl-of-year data. The data (or 1989 BIB preliminary and oould be revised. a yen currency bloc will emerge in the foresee- able future depends importantly on the open- ness, the breadth, and depth of the Japanese financial system. In • this connection, recent tional markets has declined. 1980 and 1989, the yen's share of official re- measures to deregulate Japan's financial mar- As a currency used by official agents. serve holdings among Asian countries rose kets and to free the nation's capital flows au- The importance of currencies as international sharply; in the late 1980s, about 18 percent of gur well for the yen's international use. The units of account, medium of exchange, and such holdings were in yen. However, a far implementation of additional measures will al- stores of value can also be gauged from their greater proportion (56 percent) was held in US low Japan to emerge as a world banker in the use as official reserves. The yen's share of for- dollars and a substantial share (15 percent) traditional sense, so that Japan's capital out- eign exchange holdings has consistently been was held in deutsche mark. By contrast, flows and inflows are conducted increasingly higher in Asian countries than in the world at European countries hold about 25 percent of in terms of the yen, enhancing that currency's large in recent years (see Table 2). Between their reserves in deutsche mark and only international and regional status Available July 8—Reserve Your Copy Now

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