Posted by: Kenji Hall on December 6, 2007
With billion-dollar funds from Dubai, Russia and Brazil shaking up the world’s wealthiest markets, Japan appears to be suffering from a serious case of fund-envy. Over the next year, Japan’s politicians will debate whether to do something about it—by setting up a sovereign fund of their own. The questions facing the panel of Liberal Democratic Party bigwigs who are looking into the matter: Is Tokyo playing it too safe with its $954 billion in foreign currency reserves? And if the dollar’s decline lately also signals its loss of prestige shouldn’t Tokyo have an exit plan?
For the record, U.S. Treasury securities are about as safe a place for any investor to park extra cash. They’re also extremely liquid, so it’s possible to maintain a modicum of stealth when getting in and out. That’s why Japan, the most risk-averse big investor on the planet, likes to put its money in the U.S. for safekeeping. As of September, Japan had about $582 billion of its reserves stashed in U.S. Treasury securities—about a quarter of the U.S. government debt in foreigners’ hands—according to estimates from the Treasury Department and Federal Reserve.
Of course, safe rarely makes for juicy returns. Treasury bonds and bills offer yields somewhere in the neighborhood of 3% to 4.5%. You can bet Japan’s politicians will be tempted by the potential for higher returns—and imagine Tokyo’s influence on global markets!—if they were to give the green light to cash out part of the Treasury investment and spread the largesse around. No doubt they’ll have seen how rumors that the China Investment Corp., a body set up by the Chinese government to manage an estimated $1.4 trillion in currency reserves, was eyeing Japan injected a little exuberance into Tokyo stock trading. (A day later, traders returned to reality.)
According to the Japanese financialy daily Nikkei, the fund might be several billion dollars. But that’s just a start. And let’s not kid ourselves. We’re not talking about just any old bond investment. Japanese financial authorities draw on this money to smooth out the blips in foreign exchange rates. They’ll often buy dollar-denominated bonds or T-bills to deflate the yen just enough so it doesn’t slam Japan’s export machine (or sell to assuage U.S. politicians up in arms over a weak yen). The government would also have to have a good reason to persuade Japanese financial institutions, which factor into the overall tally, to sell off Treasurys.
And even before wagering how Japan might invest its sudden windfall, you'd have to consider the impact a huge Treasurys sell-off would have on the U.S. The mere hint of it would upset the markets, send U.S. rates soaring, and strangle the U.S. economy. One economist at the U.S. Federal Reserve's Center for Pacific Basin Studies broached the topic in a July, 2005 paper titled "What If Foreign Governments Diversified Their Reserves?"
Japan's remaining investments in the U.S. wouldn't be immune to the pounding; nor would its own markets and economy. That's not the kind of thing you'd want so soon after the damage caused by the collapse of the U.S. subprime mortgage market. It's also hardly the kind of crazy gambit a risk-averse Japanese government would try. We can imagine what would happen because there was a day when panic-stricken investors thought their worst nightmare might come true.
Rewind to June 24, 1997. During a luncheon speech in New York, Japan's then-Prime Minister Ryutaro Hashimoto gave his guests indigestion by saying that continued currency fluctuations might "tempt" him to swap Tokyo's Treasury holdings for gold. I was in the room, working as a reporter for Dow Jones Newswires. Talk about a white-knuckled ride. The dollar nosedived, along with U.S. stocks and Treasury prices. Japanese authorities later backtracked, saying the real meaning of Hashimoto's remarks had been lost in translation. It was as close to a head-for-the-exits moment in the Treasurys market as you'll probably ever see.
Anybody still in favor of pooling Japan's currency reserves into a sovereign fund?