International Currrencies Made EZ: Chapter 12

* WHAT TO DO NOW: Learn more about Japan. Most investors should be diversified at least in the U.S. dollar, German mark and Japanese yen (or alternatives) most of the time. We continue our study of Japan and the yen on page one.

* EZ DIVERSIFICATION: Almost everyone should invest most of the time in the Japanese yen. Learn easy ways to diversify in yen money markets, bonds and shares on page ten.

* EZ GLOBAL PURCHASING POWER: We live in a global economy. Our purchasing power should be global, too. See how on page twelve.

Japan’s Bubble Bursts

All of Japan’s history from the time it mingled with western civilization and after World War II led to a point where Japan would become the second largest economy in the world. Its strength had reached such highs that the Tokyo Stock Market became the largest (in total capital value) in the world.

During this heyday (described last lesson) property prices rose sharply. There was a time when it was estimated that the value of real estate in Tokyo alone was worth more then all the real estate in the entire state of California!

Banks were permitted to make loans against these new higher real estate values. During 1987 and 1988, loans secured by real estate accounted for over half of all new Japanese bank financing. The stock market boomed, with the Nikkei index reaching an all time high of 38,900 by the end of 1989.

When the Bank of Japan decided that the real estate expansion needed cooling off, it raised interest rates. During the first half of 1989, the Japanese discount rate went from 2.50% to 4.25%.

The results were more devastating than anyone could have expected. The market realized that Japan was now a mature economy with all the problems that accrue to nations in that state (i.e. high wages, increased social turmoil, reduced growth, etc.), but shares and real estate were selling at earnings ratios of high growth emerging markets!

During February 1990, the market started to fall. In March the market collapsed and lost almost 30% of its value, with the Nikkei falling to 28,000.

This sudden loss in the stock market raised fear in the minds of international investors that resulted in a fall of the yen on foreign exchange markets (fear, that most powerful of all motivating factors). The Bank of Japan raised interest rates again to support the yen (the discount rate reached a high of 6.00 in 1990), and the stock market fell further. By September 1990, the Nikkei Index was just above 20,000. In just nine short months the Tokyo market had lost half its value.

Needless to say, property values plummeted along with the stock market. Banks reduced their new lending by more than 30% in 1990. Several mergers of large banks resulted. In 1991, Mitsui and Taiyo Kobe merged, forming Sakura Bank with assets of $500 billion. Citibank, the largest U.S. bank, has assets of $200 billion. At this time, the world’s eight largest banks are Japanese (based mostly on their keiretsu associations). It is perhaps ironic that the Japanese real estate and stock market crashes may yield even greater Japanese-banking dominance on the global scale.

The Bubble Keeps Bursting

Through 1992, the bubble continued bursting. In March of that year, industrial production was recorded at down 5.6% for the previous year, and department store sales fell 4.1% — the first such dip ever recorded. Money supply grew only 1.6% for the previous year in April, another all- time low.

In March 1992, the Nikkei fell below 20,000, reaching a low of 16,500 in April. This was nearly 60% below its all-time high of 38,900 in 1989, meaning that more than $2 trillion in equity had been wiped out. By 1994 the Nikkei was still moving in this range, with the 1994 high slightly above 21,000 and the 1994 low near 17,000.

Japan Today

Japan’s economy, the world’s second largest, will weather these storms. Today Japan has the highest Gross Domestic Product (GDP) per person in the world. This achievement gives Japan one of the highest standards of living of any country, and is a remarkable testament to the rebuilding process begun at the end of WWII. The following table is reprinted from Comparative Economic and Financial Statistics, published by the Bank of Japan.

Gross Domestic Production Per Capita

The following chart shows how this GDP per person has changed yearly since 1985.

Notice that Japan’s GDP per person has increased steadily, with a marked takeoff starting in 1990. The U.S. growth has been steady. Germany’s growth was steady until 1990, when growth dropped due to the unification of the country. Remember, many citizens of East Germany were almost destitute at the time of the unification. Throwing their incomes into the average dropped the GDP per person significantly. These GDP per person figures for each of the G-7 countries reflect inflation as well as increasing production per person.

The Bank of Japan

Japan’s central bank, The Bank of Japan, was founded in 1882, and was reorganized during WWII before the Japanese defeat. Although the peacetime goals of the country have clearly been different than goals during the war, the bank’s organization has stayed much the same.

Article 1 of the Bank of Japan Law states:

“The Bank of Japan has for its object the regulation of the currency, the control and facilitation of credit and finance, and the maintenance and fostering of the credit system, pursuant to the national policy, in order that the general economic activities of the nation might adequately be enhanced.”

This statement is fairly typical of statements of purpose issued by central banks around the world. All have as their stated objective the preservation of a steady money supply to promote business within the country.

The Bank of Japan’s stated functions involve: issuing the currency, extending loans to Japan’s other banks and financial institutions (through the discount-rate mechanism), operating as a go-between for the government and private business, and regulating interest rates and other monetary policy.

The Bank of Japan (BOJ) issues nine types of yen notes: 10,000, 5,000, 1,000, 500, 100, 50, 10, 5 and 1.

The BOJ does not deal with deposits or loans for the public. It works with all types of credit institutions, accepting current deposits from client banks. These current deposits earn no interest. They serve as settlement for clearing transactions, remittances of funds, etc. Loans on bills by the BOJ are made directly to financial institutions and are collateralized by securities such as Government bonds, financial debentures, and some local and corporate bonds. The rates of interest on the BOJ (the official discount rates) are officially announced and are standard to all banks. This rate functions similarly to discount rates set by the U.S. Federal Reserve, the German Bundesbank, etc.

The BOJ also trades in bills and securities of the Japanese Government. The Bank of Japan Law of 1942 authorized the bank to give uncollateralized loans to the Government and to underwrite issues of Government bonds.

The BOJ controls the money supply primarily through changes in the discount rate and bank reserve requirements, as described for the U.S. Federal Reserve and the German Bundesbank in earlier lessons. Japan has set low discount rates over the last few years. After the stock market plunge, real estate collapse and general business recession caused by rapidly rising discount rates in 1989 and 1990, rates have been kept low to stimulate the economy. With the massive surpluses the government runs yearly, it really doesn’t need to attract much money for its treasury issues. Therefore, low interest on treasuries is not a detriment to government functioning.

Central Bank Rates


                        Year     U.S.     Japan                              1980    13.00      7.25                              1981    12.00      5.50                              1982     8.50      5.50                              1983     8.50      5.00                              1984     8.00      5.00                              1985     7.50      5.00                              1986     5.50      3.00                              1987     6.00      2.50                              1988     6.50      2.50                              1989     7.00      4.25                              1990     6.50      6.00                              1991     3.50      4.50                              1992     3.00      3.25                              1993     3.00      1.75                              1994     6.00+     1.75

Structure of the BOJ

The Policy Board is the decision making body of the BOJ. It operates currency regulation, credit control, discount rates, reserve requirements. And the administration of monetary policies. The setting of reserve requirements requires approval of the Minister of Finance. Also, interest-rate changes are carried out only after proposal by the Minister of Finance.

The Policy Board is composed of seven members: 1) the Governor of the BOJ, 1) a representative from the Ministry of Finance, 3) a representative of the Economic Planning Agency, and four appointed representatives from the private sector. The representatives from the Ministry of Finance and the Economic Planning Agency do not have voting rights, so decisions are taken by vote of the Governor and the four appointed representatives. The appointed representatives are selected by the President of Japan’s Cabinet and require approval by both houses. They have terms of four years, with reappointment possible. The Governor of the BOJ usually acts as chairman of the Policy Board, but officially the chairman is selected by the Policy Board members.

The executive officers of the BOJ are the Governor, the Vice- Governor, three or more Executive Directors, two or more Auditors, and several Advisers. The Governor conducts the operations of the BOJ in accordance with the policies voted upon by the Policy Board. The Governor and Vice-Governor are appointed by the President’s Cabinet, while the Executive Directors are appointed by the Minister of Finance from among persons recommended by the Governor. The Auditors and the Advisers are appointed by the Ministry of Finance. The Governor and Vice-Governor serve five-year terms, the Executive Directors four-year terms, the Auditors three-year terms and the Advisers two-year terms. All can be reappointed. The head offices of the BOJ are in Tokyo, with 33 branch offices nationwide and 12 representative offices worldwide (including in New York and Washington, D.C.).

There are 12 large city banks in Japan. City banks, by definition, are simply those banks that are headquartered in large cities, with branches throughout the country. The 12 city banks, excluding the Bank of Tokyo, are the Daiichi Kangyo Bank, the Fugi Bank, the Sumitomo Bank, the Mitsubishi Bank, the Sanwa Bank, the Tokai Bank, the Taiyo Kobe Bank, the Mitsui Bank, the Kyowa Bank, the Daiwa Bank, the Saitama Bank, and the Hokkaido Tadushoku Bank. These banks make most of the country’s loans to large companies. They hold nearly 25% of the total deposits of all financial institutions in Japan.

In addition, there are smaller regional banks, which operate in distinct regions of the country, and sogo banks, which are restricted to making loans to smaller companies. It’s interesting to note that in 1994 the Bank of Japan removed all reserve requirements from sogo banks, effectively making their reserve requirement percentage 0%. This was aimed at increasing the money supply and stimulating small businesses throughout the country.

Foreign Exchange

The following chart supplied by the Bank of Japan shows the value of the yen compared to the dollar from 1970 to 1994 with international events marked at appropriate times. In this chart, when the dollar buys more yen, or gets stronger, the graph goes up. When the dollar buys fewer yen, or gets weaker, the graph goes down.

On the chart last page it can be seen that one dollar was worth 360 in 1970. The “Nixon shock” of August 1971 (when the dollar was removed from its link with gold) is listed above the line of the graph. Remember, after this point in time the dollar began its free fall against the yen. It went down to 253.20 per dollar during 1973 (about the time of the first major oil crisis). The dollar decreased in value after that and reached a peak of 306.85 on Dec. 8, 1975. From there it decreased in value until October 31, 1978, when it hit 176.05. The time of the sharpest fall in the value of the dollar against the yen was in the period from September 1985 to Feb. 12, 1991, after the Plaza Accord (described earlier) which deliberately weakened the value of the dollar.

Value of the Yen

Below is a chart of the yen’s value per U.S. dollar from 1980-1994. In 1995 the yen strengthen even further to an all time high of 79 yen per dollar. Then we’ll look at the long term potential of the yen.


Japan exports nearly as many goods (in US$ terms) as the United States and as much as Germany as shown below. These strong exports and the high savings rate in Japan (which means that Japanese consumers are not spending as much on imports) creates an upwards affect on the yen.

1993 Exports

U.S. $464 billion Germany $362 billion Japan $362 billion France $209 billion UK $180 billion Italy $168 billion Canada $145 billion

Trade Balance

Japan has enjoyed enormous trade balances year after year. Germany and (to a lesser degree) Canada are the only G-7 nations with a positive trade balance over the last six years. Along with the other long-term factors, this is an indicator of great strength to the yen in future.

Surplus or Deficit of Imports (in US$)


                           U.S.                Japan                  1987     -170.320 billion      80.253 billion                  1988     -137.115 billion      77.478 billion                  1989     -129.110 billion      64.217 billion                  1990     -123.395 billion      52.213 billion                  1991     - 86.633 billion      77.787 billion                  1992     -105.760 billion     106.639 billion                  1993     -138.665 billion     120.620 billion                  1994     -154.500 billion     145.200 billion

The Japanese discount rate, set by the Bank of Japan, has been lower than the discount rate of any other major industrial country for some time now. This has had the effect of revving the Japanese economy, but has slightly weakened the yen on foreign exchange markets. None the less, the overall size and strength of the Japanese economy helps to preserve long-term strength of the yen against the dollar and most currencies.

Central Bank Rates


                         Year     U.S.    Japan                               1980    13.00    7.25                               1981    12.00    5.50                               1982     8.50    5.50                               1983     8.50    5.00                               1984     8.00    5.00                               1985     7.50    5.00                               1986     5.50    3.00                               1987     6.00    2.50                               1988     6.50    2.50                               1989     7.00    4.25                               1990     6.50    6.00                               1991     3.50    4.50                               1992     3.00    3.25                               1993     3.00    1.75                               1994     6.00+   1.75

Japanese Debt

Japan has a debt to Gross Domestic Product ratio about on a par with the U.S. However, as discussed earlier, the nature of the Japanese debt is one that has promoted industry and trade, as contrasted with the U.S. debt, which is greatly taken up with welfare and interest payments on the ever-mounting debt. For this reason, the debt to GDP percentage for Japan should not adversely affect the value of the yen vs. the dollar long-term. It may, however, weaken the yen somewhat against the German mark long-term, since Germany has a somewhat lower debt to GDP percentage.


                       Belgium      134.4%                                Italy        108.4%                                Canada        82.3%                                Netherlands   78.3%                                Japan         64.9%                                USA           63.0%                                France        50.1%                                Germany       44.0%                                UK            41.9%                                Switzerland   30.0%                                Australia     29.7%

These figures come into clearer perspective when taking into account another concept: tax collections as a percentage of Gross Domestic Product. For instance, in 1990 the U.S. collected, in taxes, 30% of the 1990 GDP. Japan also collected 30% of its GDP, Germany 37%, and Belgium 44%. This gives Japan greater room to increase taxes in the future should it need to do so. This is a positive trend for the yen.

Government Tax Collections (as Fraction of 1990 GDP)


                             Belgium   44%                                   France    43%                                   Italy     40%                                   Germany   37%                                   UK        35%                                   Canada    34%                                   Switz.     31%                                   Japan     30%                                   U.S.      30%                                   Australia 30%

In the last lesson we learned an interesting way to look at the contrast of government debt to Gross Domestic Product by looking at the ratio of debt to GNP divided by the existing tax rate.

Japan in 1990 collected 30% of its GDP in taxes and its debt to GDP is 64.9%, therefore its tax to debt ratio is 64.9%/30% = 2.160. This is a high ratio compared to Germany (1.19). This ratio is even higher than the United State’s rate of 2.10. This does not bode well for the yen, if it becomes necessary for the Japanese government to raise taxes to reduce debt. Thus the high debt to GDP ratio reduces much of the strength gained from the low tax rate.

Another way a nation can resolve its debt is to let its GNP grow, maintain the same tax rate, but not increase spending. The taxes collected increase without increasing the tax rate. The increased tax collections create a surplus which can be used to retire debt.

The question we as investors must ask is whether the Japanese economy can now grow at rapid rates without increased government spending? Japan is no longer an emerging nation. The economy is now plagued by the same problems that the U.S. and other mature nations have faced…high labor costs, less motivated labor markets, growing social disturbances, etc.

The yen is sure to have strength in the short and medium term based on enormous inertia. The long term future is not so sure. We can now visualize at least a possibility that the yen will steadily deteriorate over upcoming decades like the U.S. dollar since the 1960s.

Other Indications

Other factors also point to a weaker yen in the long term. Japan has a much lower amount of gold held as reserves than either the U.S. or Germany as the table next page shows.

1993 Gold Reserves (in US$)


US 12.585 billion Germany 4.575 billion France 3.934 billion Italy 3.205 billion Japan 1.164 billion UK .886 billion Canada .290 billion

Japan Matures

As Japan’s economy matures, it will face greater challenges of higher wages, especially if the yen remains strong. These higher costs force Japanese businesses to move their factories out of Japan and into countries with lower labor costs.

This is a special problem in Japanese society because a large part of its productivity has been due to the social contract between workers and industry. This contract has been based on most workers joining a firm for life and in return expecting job permanency.

It will become harder and harder for Japanese industry to maintain this pact in the face of the rising yen and fierce competition from other Southeast countries such as South Korea, Taiwan, etc.

As this lesson is being prepared, the fabric of this social contract is already being rent as Toyota the largest car manufacturer announced that they may be forced to shut down Japanese factories.

One can understand this problem better by looking at the chart next page. In this chart you can see how Japan has a much larger portion of its economy devoted to industry then does the United States and far less of its industry devoted to community, social and government services.

If Japan’s industry slows down, it is likely that the welfare rolls will swell. There will be more unrest and unhappiness among the unemployed. A greater percentage of the Japanese economy will have to shift from industry to social services.

More Japanese will have to be employed in services that care for umemployed, aging Japanese and to deal with the other social problems that rise with unemployment, such as crime, etc.

More Japanese employed in social services and less in industry, means that there will be fewer workers (as a percentage of the labor force) that manufacture goods for export and more workers who are likely to buy imported goods.

Fewer exports will reduce the demand for yen and more imports will reduce the demand even further (as yen are required to be exchanged for other currencies to pay for the imported goods and services).

This is a position that the United States was in after World War II (but to a lesser degree, since the yen is not viewed as a world reserve currency).

This fundamental shift could well mean that in the longer term the yen will begin to have increasing downwards pressure placed upon it.


Though the yen may have long term downwards pressure, it will most likely remain a strong and key currency for years. Most investors should have some diversification in the Japanese yen most of the time. Listed below are some top performing Japanese money market, bond and equity mutual funds.

JF Yen Money Fund, 44th Floor, Jardine House, Hong Kong. Tel: 011-852-2843-8813. Fax: 011-852-2845-2421.

UBS MM Invest Yen, 26 Boulevard Grande-Duchesse Charlotte, L-2011 Luxembourg.

Credis Money Market Fund Yen, 58 Grand rue, L-1660, Luxembourg. Tel: 011-352-460-0111. Fax: 011-352-475541.

Kleinwort Benson Yen Bond Fund, PO Box 44, St. Peter Port, Guernsey, GY1 3BG, Channel Islands. Tel: 011-44-1481-727111. Fax: 011-44-1481-728317.

Guinness Flight GSF Yen Bond Fund, PO Box 250, La Plaiderie, St. Peter Port, Guernsey GY1 3QH. Channel Islands, Britain. Tel: 011-44-1481-712176. Fax: 011-44-1481-712065.

SBC Bond Portfolio Yen, 26 Route d’ Orlon, L-1140 Luxembourg. Tel: 011-352-452-0301. Fax: 011-352-452-030-700.

Carlson Japan Equity, Box 70379, S-107 24 Stockholm, Sweden. Tel: 011-46-87006360. Fax: 011-46-8-7006361.

GAM Tokyo Fonds, 4th Floor, 11 Athol Street, Douglas 1M99 1HH, Isle of Man, Britain. Tel: 011-44-1624-632632. Fax: 011-44-1624-625956.

Gartmore CSF Japan, PO Box 278, 45 La Motte Street, St. Helier, Jersey JE4 8TF, Channel Islands, Britain. Tel: 011-44-1534-27301. Fax: 011-44-1534-886689.

What To Do Now

We have seen in the first 12 lessons of this course that since the end of the Bretton Woods Currency Agreement that the U.S. dollar has fallen and fallen. Irrespective of day to day fluctuations, all individual currencies have enjoyed distinct periods of upward and downward phases. Over the years, the volatility of these phases has increased.

This freefall of the U.S. dollar is bad enough, but a more worrying factor is that it is falling at a time when normal economic indicators show the U.S. dollar should rise! This means more than just currency volatility surrounds us. We are embroiled in currency turmoil.

This kind of problem affects investors everywhere in the world. The U.S. dollar, like it or not, is still the reserve currency of the world. If its value is destroyed before a replacement is found, the current currency turmoil could become currency chaos! This is why each of us needs to use what we have learned so far in this course to begin plotting our financial course by creating our own stable currency base. Global Purchasing Power

The first way to have a stable currency base is to balance your investment portfolio to protect your global purchasing power.

We have learned in this course that purchasing power is a currency’s ability to buy something but that understanding purchasing power is not enough! We need to extend this understanding. Since we live in a global economy, we buy and sell things from all over the world and need to understand global purchasing power.

We have also learned that Global purchasing power is our currency’s ability to buy things in other countries. Take Toyota automobiles, as an example. Twenty five years ago when one U.S. dollar was worth 400 Japanese yen, a Toyota priced at two million yen, had a price in U.S. dollars of US$5,000. Today with the dollar worth just over 100 yen, (assuming all other factors remain the same), the same car costing two million yen would cost nearly $20,000.

To protect the purchasing power of our wealth, we need to hold other currencies or hedge our own. As an example, if we want to be sure we can always afford to buy Japanese imports even if our currency falls, we need to hold investments denominated in yen (or hedge the dollar versus the yen). If we always want to be sure we can buy goods in Germany, we need to hold investments in German marks.

Here is one way to protect this purchasing power. If 30% of the goods and services we buy are imported from abroad, then we should invest (or hedge our import buying) 30% of our portfolio in currencies other than our own. Such a portfolio is balanced from a global purchasing power point of view.

Thus a portfolio position with at least 30% of our investments held in a mixture of currencies (other than our own) should become our neutral currency position (rather than 100% holdings in our own currency).

This 30% (foreign currency) -70% (domestic currency) neutral position should be a point of balance from where (if we decide from time to time) we can speculate for or against our own or any other currency. We will learn several ways to speculate on currencies in later lessons, but here let’s look at an easy way to attain a balanced portfolio.

To keep things easy, one simple general rule of thumb assumption is that 30% of our goods are imported and half of these imported goods come from Europe, half from Asia and Japan (if we are U.S. residents). Residents elsewhere might want to assume 34% in Japan, 33% in Europe and 33% in the U.S.

50 – 50 Currency Split

Based on the assumption above, one simple way to attain a balanced portfolio is to hold in theory 15% of one’s portfolio in Japanese yen and 15% in ECU (European Currency Unit) or German marks. Non U.S. investors would invest in theory 10% of their portfolio in yen, and 10% in the U.S. and 10%, Europe. In the next lesson we will learn ways to build such a portfolio.


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