Europe’s bit part in Japanese drama

Date: 25/06/1998

The ECB could do much to rebuild confidence in the Far East, but for now its hands are tied. Tim Jones reports

IT IS unfortunate for Europe's monetary fire-fighters that the greatest threat to the world economy for nearly two decades has come seven months too early.

As a result, in addition to taking the leading role in straightforward foreign policy issues, the Indian subcontinent's nuclear arms race or forcing the European pace on mollifying Turkey, the Americans have also had to shoulder most of the burden of crisis management in Asia.

There may be a European Central Bank and a Euro-11 club of finance ministers representing a single currency zone to rival the US in size, population and trading presence, but Europe still lacks global policy clout.

It was the Americans who convened a crisis meeting of top financial officials from the Group of Seven (the US, Japan, Germany, France, Italy, the UK and Canada) in Tokyo last weekend, and told the Japanese government that it had a "window of opportunity" to sort out its deep-rooted economic and financial problems.

They called on Prime Minister Ryutaro Hashimoto to take serious steps to boost the Japanese economy and overhaul a banking system which is creaking under a cool 500 billion ecu of bad and doubtful loans. This would be vital, they said, "to Japan, to the recovery of Asia, particularly those countries affected by financial market turbulence, and to the entire world economy".

The Japanese economy actually shrank 5% in the first three months of this year compared with the same period in 1997. Worries are growing throughout the world economic establishment that Japan's recession and the collapsing yen will spark a slump first in Asia and then globally.

To buy Hashimoto time, US President Bill Clinton last week met his top aides, his 'monetary Kissinger' Deputy Treasury Secretary Lawrence Summers and, significantly, his National Security Adviser Sandy Berger, to address the crisis.

Word had reached them that the yen's weakness was a threat to Chinese competitiveness and Beijing would devalue the renminbi unless something was done.

This is the West's worst nightmare. A Chinese devaluation would provoke a Hong Kong devaluation which would start a chain reaction throughout the region. Asia's crisis would intensify, since heavy local borrowers would be even less capable of paying off their foreign currency debt. Asian goods would flood into western markets at knock-down prices and throw people out of work.

For the first time in three years, Clinton authorised the Federal Reserve Bank of New York to intervene aggressively and publicly in the currency markets, buying yen and selling dollars to the tune of 6 billion ecu in one day.

It worked, and the yen rose quickly. But this was mostly due to the understanding in the financial markets that Hashimoto would carry out his pledges, rather than the currency intervention itself.

As St Louis Federal Reserve Bank president William Poole remarked last week to the Market News press agency, simply buying currency would be ineffective because "the size of intervention relative to the market is trivial", but it "might call attention to more fundamental changes".

By reversing the one-way collapse of the yen, the US has both bought time for Japan and reinforced its position as the world's monetary enforcer. If currency dealers can be sure that the Fed and the Bank of Japan are prepared to intervene when the dollar soars above 140 yen and that Hashimoto will carry out his promises, the Clinton administration will have done its work.

It will be its most successful rescue bid since 1995 when Summers persuaded Clinton to bypass congressional Republicans and arm-twisted G7 countries into lending 45 billion ecu to Mexico.

Yet until the Tokyo meeting, G7 members Germany, France and Italy - the vanguard of the euro-11 area - gave the impression that they were unaware of the perils of letting things lie. For months, they have sought to play down the potential impact of the Japanese crisis on their economies.

The European Commission has made it clear that its growth forecast for the euro-11 of 3.0% this year and 3.2% next will not be revised unless the yen drops to 150-per-ecu and stays there.

Commission forecasters believe that a 'normal' recession in Japan and no devaluation domino effect could be absorbed by the expected resurgence of domestic demand in continental Europe.

As the crisis deepened last week, critics began to voice their frustration at the inaction. Norbert Walter, the influential chief economist at Deutsche Bank in Frankfurt, called on the fledgling ECB to join in the operation to prop up the yen.

It is significant that this appeal came from one of Europe's top banks, since it is they which stand to lose most if the situation worsens.

However, this is one of the few areas of policy where the ECB is not the pace-setter.

Antonio Fazio, governor of the Bank of Italy and a member of the ECB's governing council, revealed last week how slowly the new bank could respond to financial crises.

Only in extreme cases would ECB President Wim Duisenberg and the six-member executive board be allowed to deploy the ECB's 50-billion-ecu foreign currency reserves on international markets without first consulting national central bank governors.

"If disaster strikes Japan in the middle of the night, then the reserves of the ECB are there and Duisenberg needn't wake up Tietmeyer," said Fazio, referring to the German Bundesbank president.

"But obviously, at eight o'clock in the morning, the central bankers will be consulted."

Dealing with a Japanese meltdown is a job for politicians and, with the Euro-11 club searching so hard for a role in life, it will find nothing more suited to its talents than this.

Only if the euro strengthened so rapidly against the yen that it threatened to deflate the economy, thus threatening 'price stability' in the opposite direction, would the ECB be permitted to act alone. In every other case, the bank would have to follow the rules set out in Article 109 of the Maastricht Treaty, which allocates these powers to ministers.

Last year's Amsterdam summit called on ministers, the Commission and the ECB to study "effective ways" of implementing Article 109.

It specifies that while the ECB should have a say in deciding the euro's rate against the dollar or the yen, the final word rests with finance ministers and their bosses.

This is because the rate of the euro abroad will have a major impact upon general economic conditions, such as industry's ability to export goods and the penetration of imports, and these are still the responsibility of governments.

There is undoubtedly a reluctance to intervene in the financial markets without extreme provocation. If the market turns the wrong way, the losses for central banks can be enormous: the Bundesbank lost 3 billion ecu in one day in 1987. Heavy buying of a foreign currency can also boost the domestic monetary base and threaten inflation.

At the moment, neither prospect is likely. The threat of inflation on continental Europe is minimal.

The potential gains of throwing the new power of the ECB and Euro-11 behind Hashimoto's reforms and rescuing the world economy from collapse far outweigh the risks.

Major feature. The European Central Bank could do much to rebuild confidence in the Far East, but for now its hands are tied.