Chronology of the Internationalization of the Yen

(1) Interest in the international role of the yen was first sparked in thediscussion seeking a new international monetary system in the wake of the collapse of theBretton Woods system, that is the adoption of a floating exchange rate system in March1973 following the "Nixon shock" of August 1971.

(2) Through the two oil shocks massive amounts of oil-dollars wereaccumulated, and international financial markets started on a path toward majortransformation. Euro-markets expanded, and international monetary flows of funds increasedin size and speed. During this period, the United States continued to suffer a seculardecline in its global economic standing, provoking a further decline in internationalconfidence in the dollar. Simultaneously, Japan and Germany emerged from these shocks withrenewed vigor to claim an increasingly important role in the global economy. A combinationof these factors served to generate growing interest in the international roles of the yenand German mark. In December 1980, a thoroughly revised Foreign Exchange and Foreign TradeControl Law went into effect in Japan. As part of the move toward economic globalization,the new legislation effectively promoted Japan's cross-border monetary flow.

(3) In October 1983, "the internationalization of the yen and theliberalization of financial and capital markets" were formally identified as majorpolicy objectives as enunciated by the Minister of Finance and included in theComprehensive Economic Measures adopted by the government. Coinciding with PresidentReagan's visit to Japan, the Yen-Dollar Committee was established in November 1993 andeventually reached an agreement (May 1984) concerning the liberalization of Japan'sfinancial and capital markets, the internationalization of the yen, and the lowering ofthe barriers to access for foreign financial institutions participating in Japan'sfinancial and capital markets. At the same time, "Current Status and Prospects forFinancial Liberalization and the Internationalization of the Yen" was announced. Thisdocument systematically outlined specific approaches and measures for promoting theinternationalization of the yen. Against the background of growing domestic and globalinterest in the internationalization of the yen, the Minister of Finance assigned the taskof conducting deliberations on the internationalization of the yen to the Council onForeign Exchange and Other Transactions. In March 1985, the Council submitted its reportwhich included the following specific measures for promoting the internationalization ofthe yen: [1] financial liberalization (particularly the continued liberalization ofinterest rates, and the further development and expansion of open short-term capitalmarkets); [2] liberalization of the euro-yen market as the first step toward improving theconvenience of the yen for nonresidents; and [3] establishment of a Tokyo offshore marketto facilitate euro-yen transactions in Tokyo.

(4) Responding to these developments, steady progress was made through thesecond half of the 1980s and the 1990s in the program for financial liberalization,including the easing and abolition of euro-yen regulations. The Tokyo offshore market wasestablished in December 1986 and continues to the present.

Note: Throughout the 1970s and 1980s, both Japan andEuropean countries accepted the internationalization of their domestic currencies as a"natural development," but otherwise adopted a relatively passive stance towardthis development. During this period, these countries tended to believe that the entry andexit of funds exceeding the capacity of their domestic financial markets would destabilizethe foreign exchange markets, or that these movements would undermine the effectiveness ofmonetary policies by weakening the monetary authority's control over domestic moneysupply. Because of these misgivings, these countries generally pursued economic policieswhich were designed to reduce the negative impact of the internationalization of theircurrencies. As a result of the progress toward economic globalization and the free andintensified movement of capital, the internationalization of the yen is now viewed in acompletely different vein. Today, it is appreciated as a development which adds depth tothe markets and which is desirable from the perspective of policy management utilizingmarket functions.

(Attachment) Key Events Surrounding the Internationalization of the Yen

2. International Currencies

The term “international currency” generally refers to a currencyof invoicing and settlement used in international transactions involving financial assetsand the trade of goods and services. In addition, an international currency is a currencyheld as a form of international liquidity and reserves by private-sector economic entitiesand monetary authorities.

In international economic transactions, consisting of cross-bordertransactions, international currencies serve the same purposes as in domestic economictransactions. A currency is rendered legal tender within the country of its issue throughlegislative action and serves as a medium of exchange, a unit of account, and store ofvalue. While no single currency is legal tender throughout the world, for purposes ofconvenience, some currencies have functioned as international currencies on the basis ofhistorical experience and practice.

2. Functions

(1) Invoicing currency (Functions as a unit of account in international transactions, such as in the invoicing of oil prices)

(2) Currency peg (Functions as a currency or gold to be pegged in a fixed exchange rate system)

(3) Transaction currency (Functions as a medium of exchange in international transactions)

(4) Intervention currency (Functions as a medium for intervention by monetary authorities for the control of exchange rates)

(5) Asset currency (Functions as an international store of value for the private sector)

(6) Reserve currency (Functions as an international store of value for monetary authorities)

3. Requirements

The following are requirements for a currency to be used as aninternational currency.

(1) The country issuing the currency must have a substantial economic scale.

(2) Liberalized and well-developed financial markets must exist in which the currency can be invested and exchanged with other currencies.

(3) The currency must enjoy international confidence.

Reference: Definition of Key Currency

“Key currency” is generally used to refer to the most widelyused or centrally positioned international currency. However, there is no clear definitionof the term.

1. General Comments

• Yen-invoiced trades accounted for about 5% of world trade in 1992, a low figure given the size of Japan's economy and other factors. (Japan’s nominal GDP made up 14% of the world total, and Japan's share in world trade was approximately 7% in 1997.)

• The ratio of yen-invoiced exports from Japan has remained essentially unchanged at between 35% and 40% for more than ten years. This ratio of home currency- invoiced exports is substantially lower than in other major industrialized countries.

• The ratio of yen-invoiced imports to Japan has been gradually rising as a result of the growing foreign investments by Japanese companies, leading to an increase in product imports by these firms. Nevertheless, as of 1997, this ratio was slightly above 20%. This ratio of home currency-invoiced imports is substantially lower than in other major industrialized countries.

2. Specific Points

(1) Current Situation

   [1] Exports

• A preponderant share of Japanese exports to the United States are invoiced in dollars. By comparison, the majority of Japanese exports to Europe is invoiced in yen (about 35%) or various European currencies (over 50%), while the share of the dollar is low at 13%.

• Approximately one-half of Japanese exports to Asian countries, excluding China, are invoiced in yen. Dollar-invoiced exports account for about the same ratio.

• Export products which enjoy highly competitive positions tend to be invoiced in the currency of the exporting country. For this reason, the ratio of yen-invoiced exports is higher for such products as machinery, and is particularly high in the case of cars.

   [2] Imports

• A preponderant share of Japan's imports from the United States is invoiced in dollars (over 70%). On the other hand, the yen is widely used in imports from Europe and accounts for 44% of this trade. Various European currencies account for nearly the same ratio.

• Dollar-invoiced goods make up a very high ratio of Japan's imports from Asia (over 70%).

• The import of products for which Japanese importers enjoy a dominant position in the international market is performed in yen.

(2) Background Factors

• Trade of internationally traded commodities and raw materials has been traditionally conducted in dollars. One of the reasons that dollar-invoiced goods make up a high ratio of Japan's imports from Asia is said to be that primary products account for much of this trade.

• The dollar is often used in intra-firm trade between Japanese parent companies and their overseas subsidiaries, because parent companies assume the foreign exchange risks.

• The fact that many Asian currencies have virtually been pegged to the U.S. dollar until recently has been cited as a reason why trades with Asia have often been carried out in dollars.

• It is said that trades between industrialized countries are often carried out in the currency of one of the two nations. The fact that the share of manufactured products in Japan's total imports is low compared to other major industrialized countries has been cited as a reason why the share of yen-invoiced imports is low. (Similarly, the reason that yen-invoiced transactions make up a higher percentage of Japan’s imports from Europe is that manufactured products make up a high percentage of those imports.)

3. Comparison with Other Major Industrialized Countries

• In the case of the United States, the dollar invoicing accounts for a preponderant share of both imports and exports. For the United Kingdom, France, and Germany, the ratio of home currency-invoiced trade is significantly higher than in the case of Japan.

• The following are cited as background issues to the relatively high ratio of mark-invoiced trade for Germany, a nation with which Japan is often compared.

(1) The proportion of German trades with other European countries is high.In comparison, Japanese trades are more diverse in geographical distribution.

(2) (While German trade with non-European countries is very limited inscale) The ratio of home currency-invoiced transactions in German trade with the UnitedStates and Asia is higher than in the case of Japan. One factor behind this is said to bethe high international competitiveness of German products, which makes it easier forGerman traders to insist on mark-invoiced transactions.

(3) A review of the trade structures of Japan and Germany reveals thatwhile both countries are major exporters and importers of manufactured products, rawmaterials and energy resources account for a smaller portion of German imports as comparedto Japan.

4. Correlation of Asian Currency Movementswith the Dollar and the Yen

Prior to the currency crises, many Asian currencies were virtually peggedto the dollar. Since the beginning of the crises, Asian currencies underwent a period ofextreme volatility and sharp depreciation, although the period and extent of fluctuationsvaried from one country to another. More recently, these currencies have regained a degreeof stability.

The correlation of Asian currency movements with those of the U.S. dollarand with those of the Japanese yen during this period can be summarized as follows.

Note: Correlation coefficients were computed using theweekly rates of change as observed over rolling periods of the past six months.Correlation with the dollar was computed using movements of Asian currencies and thedollar against the yen, and correlation with the yen was computed using the movementsagainst the dollar.

1. Features Prior to the Asian Currency Crises

• All currencies maintained an extremely high degree of correlation to the dollar (average coefficient: 0.94-0.99). (The Philippines [average coefficient of 0.75] was the exception.)

• The correlation of Asian currencies with the yen was lower than that with the dollar. No significant correlation was detected in the case of Indonesia, South Korea, the Philippines, and Taiwan (average coefficient: 0.08 - 0.12). On the other hand, the Thai and Singaporean currencies consistently exhibited a positive correlation (average coefficients: 0.57 and 0.45, respectively), the level of which changed over time. The Malaysian ringgit also exhibited a positive correlation to the yen, with the exception of a certain period of time.

2. Recent Situation

• While the high degree of correlation of Asian currencies with the dollar observed prior to the crises has been significantly reduced, their correlation with the yen has risen (average coefficient: 0.22 - 0.48). There were periods when some currencies, including the Singapore and Taiwan dollar, exhibited a high degree of correlation with the yen, reaching a level of 0.8.

• The correlation between the yen and the Indonesian rupiah has only recently begun to increase (about 0.4 since the beginning of 1999), lagging behind other Asian currencies.

• As the Thai and Singaporean currencies exhibited relatively strong correlation with the yen prior to the currency crises, no marked increase in correlation has been observed after the crisis. (In the case of Thai baht, correlation with the yen actually receded from 0.57 to 0.39.) It is notable that the correlation of these currencies with the dollar has declined sharply. In particular, the correlation between the Thai baht and the dollar now ranks as the second lowest in the region, standing next to the Indonesian rupiah.

Reference: Regarding the Thai Baht

The relatively high degree of pre-crisis correlation between the Thai baht and the yen can be attributed to the fact that the baht was formally pegged against a currency basket which contained the yen. (The make-up of the basket remained undisclosed, but the yen reportedly was assigned a weight of approximately 10%.)

Among other Asian currencies, a distinctive feature of the baht is that its post-crisis correlation with the yen has actually declined. In view of the fact that the baht's correlation with the dollar has also significantly declined during the same period, the baht's unusual behavior may be attributed to its transition from a formal basket-peg to a floating exchange rate system.

According to Subcouncil Chairman Ito and his co-authors, a regression analysis of the movement of the baht using the yen, dollar, and other explanatory variables revealed that the coefficients of the yen were significant during the period from January 1997 through June 1997 and the period from January 1999 through March 1999. Since the coefficients for the period from January 1999 through March 1999 were larger than those for the other period, the baht can be considered to be more closely correlated to the yen after the crisis.

Correlation Coefficients of AsianCurrencies to U.S. dollar and to Yen

(Note 1) Figures are average correlation coefficients between the weekly rates ofchanges of 2 currencies as
observed over past six months.
(Note2)  "Prior to the Asian Currency Crises" refers to the period untilJun. 1997, except for Korea (the period
until Oct. 1997).
"Period of Stability" refers to the period when the absolute value of rates ofchanges against U.S. dollar
was almost under 1%. These periods of each country are as follows:
Thailand:  Since May 1998
Korea: Since May 1998
Malaysia: Since Aug. 1998
Philippines: Since Aug. 1998
However, periods for Indonesia, Singapore and Taiwan are divided into "Prior to theAsian Currency
Crises" and "After the Asian Currency Crises" because of too largefluctuation of Indonesian rupiah and
too small fluctuation of Singaporean and Taiwan dollars.

Note 3) Data since Jan. 1987 are used except for Indonesia and Philippines, for each ofwhich data since May 1992
are used.

5. Seigniorage

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[References and Appendices]