Japan's Currency Intervention: Policy Issues

Japan’s Currency Intervention: Policy Issues
Updated March 25, 2008
Dick K. Nanto
Specialist in Industry and Trade
Foreign Affairs, Defense, and Trade Division

Japan’s Currency Intervention: Policy Issues
Summary
The rapid depreciation of the value of the dollar on foreign exchange markets
is mirrored by an equally rapid appreciation of currencies, such as the yen (and Euro).
This has raised concerns that Japan may intervene in currency markets for the first
time since March 2004 to shore up the value of the dollar and slow the appreciation
of the yen. Japan has conducted such intervention in the past by purchasing dollars
and selling yen on foreign exchange markets. This intervention has raised concerns
in the United States and brought charges that Tokyo is manipulating its exchange rate
in order to gain unfair advantage in world trade. This coincides with similar charges
being made with respect to the currencies of the People’s Republic of China and^th
South Korea. In the 110 Congress, H.R. 2886 (Knollenberg)/S. 1021(Stabenow)
(Japan Currency Manipulation Act), H.R. 782 (Tim Ryan)/S. 796 (Bunning) (Fair
Currency Act of 2007), S. 1677 (Dodd) (Currency Reform and Financial Markets
Access Act of 2007), and S. 1607 (Baucus) (Currency Exchange Rate Oversight
Reform Act of 2007) address currency misalignment in general or by Japan in
particular.
In the past, Japan has intervened (bought dollars and sold yen) extensively to
counter the yen’s appreciation, but since 2004, the Japanese government has not
intervened significantly, although some claim that Tokyo continues to “talk down the
value of the yen.” This heavy buying of dollars resulted in an accumulation of
official foreign exchange reserves that exceeded a record $979 billion (February

2008) by Japan. The intervention, however, seems to have had little lasting effect.

Estimates on the cumulative effect of the interventions range from an undervaluation
of the yen of about 3 or 4 yen to as much as 20 yen per dollar, although recent
appreciation of the yen has erased most of such undervaluation.
In 2007, the U.S. Secretary of the Treasury indicated that it had not found
currency manipulation by any country, including by Japan. An April 2005 report by
the Government Accountability Office reported that Treasury had not found currency
manipulation because it viewed “Japan’s exchange rate interventions as part of a
macroeconomic policy aimed at combating deflation....” In its May 2006 report on
consultations with Japan, the International Monetary Fund (IMF), likewise, did not
find currency manipulation by Japan.
One problem with the focus on currency intervention to correct balance of trade
deficits is that only about half of the increase in the value of a foreign currency is
reflected in prices of imports into the United States. Periods of heaviest intervention
also coincided with slower (not faster) economic growth rates for Japan.
Major policy options for Congress include (1) letting the market adjust; (2)
clarifying the definition of currency manipulation; (3) requiring negotiations and
reports; (4) requiring the President to certify which countries are manipulating their
currencies and taking remedial action if the manipulation is not halted; (5) taking the
case to the World Trade Organization or appealing to the IMF; or (6) opposing any
change in governance in the IMF benefitting Japan. This report will be updated as
circumstances require.

Contents
Most Recent Events................................................1
In troduction ......................................................2
The Interventions..................................................5
Economic Studies..................................................7
The Link Between Exchange Value and Trade..........................10
Intervention or Manipulation?.......................................13
Policy Issues.....................................................16
Let the Market Adjust (Do Nothing)..............................17
Clarify the Definition of Currency Manipulation....................18
Require Negotiations and Reports................................20
Certify Currency Manipulation and Take Remedial Action............21
Actions with the IMF, World Bank, WTO, and OPIC.................21
Legislation ......................................................22
Appendix .......................................................24
List of Figures
Figure 1. Recent Changes in the Yen/Dollar Exchange Rate................1
Figure 2. Japan’s Real Effective Exchange Rate
(March 1973=100).............................................4
Figure 3. Japan’s Exchange Rate and Foreign Exchange Reserves:
1972-2006 ...................................................6
Figure 4. Changes in Japan’s Foreign Exchange Reserves and in the
Yen/Dollar Exchange rate with Interventions and GDP Growth Rates,
1972-2006 .................................................13
Figure 5. Indexes of the Value of the Japanese Yen, German Mark, and
European Union Euro per U.S. Dollar.............................16
List of Tables
Japan’s GDP Growth Rate, Yen/Dollar Exchange Rate, and Foreign
Exchange Reserves, 1970-2008..................................24

Japan’s Currency Intervention:
Policy Issues
Most Recent Events
^!March 20, 2008. The yen appreciated to 99 yen per dollar, a 20%
rise since its low on June 24, 2007.
^!September 5, 2007. The unwinding of yen carry trade positions
(selling investments in non-Japanese financial instruments and
buying yen to repay yen loans) has caused the yen to rise since its
low of 124.1 yen per dollar on June 24, 2007. The rise has been
accelerated by the turmoil in the subprime mortgage market from
mid-August 2007.
^!June 24, 2007. In its Annual Report for 2006/2007, the Bank for
International Settlements stated that “there is clearly something
anomalous in the ongoing decline in the external value of the yen”
and warned investors betting against the yen to remember 1998
when it soared suddenly.
Figure 1. Recent Changes in the Yen/Dollar Exchange Rate

^Y^{en/$ Exchang}^{e R}^a^te
¹⁴⁰
^U.^S.^M^o^rt^gage
¹³⁰^W^eak^{er Y}^eⁿ^M^a^rk^et^Turm^oil
^St^{ronger Dollar}^124.¹
¹²⁰
^114.⁵
¹¹⁰^St^{ronger Y}^eⁿ^113.⁸^118.⁸
^W^eak^{er Dollar}^108.²
¹⁰⁰
⁹⁰^96.⁹
⁸⁰
⁰⁷¹^/³¹²^/²⁸³^/³⁰⁴^/³⁰⁵^/³¹⁶^/²⁹⁷^/³¹⁸^/³¹⁹^/²⁸⁰^/³¹¹^/³⁰²^/³¹⁰⁰⁸²^/²⁹³^/²⁰
²⁰¹¹¹^/²
²^/³¹
¹^/¹^/
^M^onth/D^a^y^/^Y^ear
^Dat^a^Source:^PACI^F^I^C^{Exchange Rat}^e^Service

Introduction
The rapid depreciation of the value of the dollar on foreign exchange markets
is causing fundamental changes in the trading relationships between the United States
and other nations whose currencies have appreciated lately. Japan, in particular, has
seen its currency rise by 20% relative to the dollar (comparable to the 18% rise in the
Euro over the same period of time).
This is raised concerns that Japan may intervene in currency markets for the first
time since March 2004 to shore up the value of the dollar and slow the appreciation
of the yen. Japan has conducted such intervention in the past by purchasing dollars
and selling yen on foreign exchange markets. This has caused Japan’s holdings of
foreign currency reserves to reach $979 billion (February 29, 2008), second only to
the $1.5 trillion held by China (December 31, 2007). Japan earns some $12 billion
per month in interest on its holdings of foreign currency and other reserve assets.
Japan’s past intervention to slow the upward revaluation of the yen raised
concerns in the United States and brought charges that Tokyo was manipulating its
exchange rate in order to gain unfair advantage in world trade. This coincided with
similar charges being made with respect to the currency of China. This report
provides an overview and analysis of Japan’s official intervention into currency
markets, reviews various studies on the probable effect of that intervention, examines
the charge that Japan has manipulated its exchange rate as defined by the
International Monetary Fund (IMF), and reviews legislation and policy options.
Foreign governments intervene into currency markets by buying foreign
exchange — usually dollars, Euros, or British pounds — in order to increase demand
for these currencies and support their value relative to the intervening government’s
own currency. Likewise, they can sell foreign exchange in order to decrease demand
for target foreign currencies and increase the value of the country’s own currency.
In Japan’s case, it has frequently bought dollars from its domestic exporters in
exchange for yen and used those dollars to buy U.S. Treasury securities or other
liquid dollar assets.
In the 110^th Congress, H.2886 (Knollenberg)/S.1021 (Stabenow) (Japan
Currency Manipulation Act) would require negotiation, reports, and other action with
respect to Japan’s currency actions. This bill states in its findings that Japan’s
exchange rate provides a subsidy to Japanese exporters and an unfair competitive
advantage for Japanese automobile manufacturers. H.R.782 (Ryan)/S.796 (Bunning)
(Fair Currency Act of 2007) would provide that exchange-rate misalignment by an
foreign nation is a countervailable export subsidy and also would clarify the
definition of manipulation with respect to currency.
S.1607 (Baucus) (Currency Exchange Rate Oversight Reform Act of 2007)
would require the Treasury Department to identify currencies that are fundamentally
misaligned and would require action to correct the misalignment. S.1677 (Dodd),
Currency Reform and Financial Markets Access Act of 2007, would require the
Treasury Department to identify countries that manipulate their currencies regardless

of their intent and to submit an action plan for ending the manipulation, and gives
Treasury the authority to file a case in the WTO.
Concern over currency manipulation, intervention, and misalignment stems
from the basic U.S. interest in American national prosperity. Manipulation of
exchange rates to undervalue foreign currencies potentially can increase the U.S.
trade deficit,¹ increase U.S. dependency on foreign investors to finance U.S. budget
deficits, affect the level of U.S. interest rates, and negatively affect U.S. businesses
competing with imports or exporting.
In Japan’s case, the Bank of Japan (in consultation with the Ministry of Finance)
has bought U.S. Treasury securities and other liquid dollar assets at times when the
value of the dollar relative to the yen was declining. The intended result was to keep
the value of the yen from appreciating too quickly in order to keep the price of
Japanese exports from rising in markets such as those in the United States and to
maintain the profitability of those exports.
Some experts argue that the yen has been undervalued by 10% to 29% or more,
although recent appreciation of the yen largely negates this argument. The
underlying concern is that an undervalued yen gives many Japanese manufacturers
a significant price advantage over U.S. competitors. The U.S.-headquartered
automobile industry, for example, claims that an undervalued yen generates a price
advantage of about $4,000 per car to vehicles made in Japan and a resultant surge in
sales of such vehicles in the United States.²
Another measure of the exchange rate takes into account differences in inflation
rates between those in Japan and in the United States (real rate) and provides
relatively greater weight to currencies with which Japan trades the most (effective
rate). These adjustments produce a real effective exchange rate. As shown in Figure
2, this adjusted value of the yen reached a 20-year low in May 2007, but it has
appreciated since then. Any undervaluation since 2004 arguably has resulted from
private market forces and inflation rates (resulting from macroeconomic policy) in
both countries rather than from government currency intervention.³
Economic studies indicate that currency intervention for large countries with
floating exchange rates, such as Japan, merely slows the rate of currency appreciation
or depreciation over the short run (less than 30 days) and has little effect over the
long term. Whether Japan can be considered to have manipulated its exchange rate
under criteria set by the International Monetary Fund (IMF) is open to debate. The
IMF and the Secretary of the Treasury have not found such manipulation in recent

¹ The overall size of a nation’s current account balance (trade in goods and services plus
unilateral transfers) is determined mainly by rates of savings and investment, interest rates,
and other factors, but the foreign exchange rate plays a key role in adjusting for imbalances.
² Collins, Stephen. How the Misaligned Yen Hurts U.S. Automakers, Real Clear
Politics.com. March 8, 2007.
³ The real effective value of the yen is an index of the exchange rate adjusted to account for
differing rates of inflation among Japan’s trading partners and for the share of trade with
each major trading partner in Japan’s total trade. It is calculated by the Bank of Japan.

years,⁴ but others charge that such manipulation has taken place. Although, Japan
claims that it has not intervened in foreign exchange markets since March 2004,
some claim that Japan still “talks down the value of the yen.”
Figure 2. Japan’s Real Effective Exchange Rate
(March 1973=100)

^Index
²⁰⁰
^{3/2004 In}^t^e^rv^en^tⁱ^oⁿ
^S^t^ronge^{r Y}^eⁿ^S^t^oppe^d
^{Weaker Yen}
¹⁵⁰
¹⁰⁰
^{9/11/2001 T}^e^rro^rist
^A^t^t^acks
⁵⁰^{7/1997 A}^s^ian^Fⁱⁿ^aⁿ^c^{ial C}^r^isis
^{4/1995 St}^rongest^y^e^{n -}^-^{80 y}^e^{n per $1}
^{1/1991 Gu}^lf^War
^{9/1985 Plaz}^a
^A^cco^rd
⁰
⁷³⁹⁷⁵⁹⁷⁷⁹⁷⁹⁹⁸¹⁹⁸³⁹⁸⁵⁹⁸⁷⁹⁸⁹⁹⁹¹⁹⁹³⁹⁹⁵⁹⁹⁷⁹⁹⁹⁰⁰¹⁰⁰³⁰⁰⁵⁰⁰⁷⁰⁰⁸
¹⁹¹¹¹¹¹¹¹¹¹¹¹¹¹²²²²²^/²
^Y^ear⁽^J^anuar^y⁾
^Dat^a^Source:^Bank^of^Japan
In 2008 as the yen has appreciated, the question before Japanese policymakers
is whether or not to intervene again. Pressures from Japanese industries to do so are
increasing. Toyota Motors, for example, reportedly bases its earnings on an
exchange rate of 105 yen per dollar. Every 1 yen appreciation against the dollar
causes a $350 million drop in its operating profit, although such adverse effects can
be mitigated over the longer run. Japanese carmakers reportedly place the
appropriate exchange rate at about 90 to 100 yen per dollar. Yen appreciation also
causes the value of Japanese stocks to decline. However, until the rate goes below
85 to 90 yen per dollar, some think the government of Japan would not consider
⁴ U.S. Treasury. Semiannual Report on International Economic and Exchange Rate Policies,
December 2007. International Monetary Fund. Japan — 2006 Article IV Consultation
Concluding Statement of the IMF Mission, May 24, 2006 (contains no mention of exchange
rate manipulation).

intervening.⁵ Government financial officials in Japan have indicated that they are
“monitoring the foreign exchange movements with “great interest.”⁶
One problem with intervening in today’s markets is that there has been a sharp
rise in the volume of transactions. According to the Bank for International
Settlements, the daily trading of foreign currencies through traditional foreign
exchange markets totaled more than $3.2 trillion in April 2007, up sharply from $1.9
trillion in 2004. Another $2.4 trillion was traded in the over-the-counter foreign
exchange derivatives market for a total of $5.6 trillion per day in both markets.
About 86% of the trading on traditional foreign exchange markets was in dollars.⁷
These amounts are so large that for any intervention to have an effect, it arguably
would have to be coordinated among Japan, the United States, and the European
Union with possible cooperation from China.
The Interventions
In 1971, when the link between the U.S. dollar and gold was severed and the
dollar was allowed to float within certain bands, the yen began to appreciate in value.
The yen/dollar exchange rate, established during the U.S. occupation of Japan in
1949, had been held at 360 yen per dollar for 22 years. Since then, it appreciated to
around 105 yen per dollar in early 2005, but in late 2005 it had depreciated to around

120 yen per dollar before rising slightly to about 119 yen per dollar in March 2007.

Japan’s government has intervened in currency markets to buy dollars or other
foreign exchange at times when the yen was appreciating at a pace that it considered
to be too rapid. Japan also has intervened by selling dollars at times when the
Japanese government (Bank of Japan and Ministry of Finance) felt that the yen was
depreciating too rapidly. The net result of this intervention is that Japan’s holdings⁸
of foreign exchange reserves have risen to $902 billion by July 31, 2007.
As can be seen in Figure 2, the most significant of Japan’s interventions to
counter the yen’s appreciation took place in 1976-1978, 1985-1988, 1992-1996, and

1998-2004. Since March 2004, the Japanese government has not intervened

⁵ “The Yen Also Rises; Foreign Exchange,” The Economist (London), March 22, 2008. P.
101. Dan Sloan. “Sakakibara, Mr Yen, Says Japan Intervention Unlikely,” Reuters, March

17, 2008.

⁶ Takashi Nakamichi, Tomoyuki Tachikawa, and Akane V. Uchida, “Tokyo Frets About the
Dollar but Gives Little Guidance,” The Asian Wall Street Journal, March 17, 2008, p. 11.
⁷ Bank for International Settlements, Triennial Central Bank Survey: Foreign Exchange and
Derivatives Market Activity in April 2007, September 2007. pp. 1-5. Available at
[http://www.bis.org/ publ/rpfx07.pdf].
⁸ Japan. Ministry of Finance at [http://www.mof.go.jp/english/e1c006.htm]. Note that
Japan’s foreign exchange reserves rise naturally because of interest earned on investments
of the foreign exchange in U.S. Treasury securities and other financial instruments.

significantly in currency markets to support the value of the dollar.⁹ Figure 3 also
shows that despite heavy buying (or selling) of dollars during certain periods of time,
the intervention seems to have had little lasting effect. It might have slowed the
change in value of the yen, but the appreciation (or depreciation) occurred anyway.
This is called “leaning against the wind” in economic parlance or intervening to
oppose strong short-term trends rather than to reverse the direction of change. In
most cases, Japan’s intervention resulted in the “smoothing” of fluctuations in
exchange rates rather changing the direction of movement. As one author put it,
Japan seems to have won many daily battles with the foreign exchange market, yet
it lost the war.¹⁰
Figure 3. Japan’s Exchange Rate and Foreign Exchange Reserves:

1972-2006

^For^e^{ign Ex}^c^{hange Res}^e^r^v^es⁽^$^Billions⁾^Y^{en per}^Dol^l^a^r^Ex^{change Rat}^e
¹⁰⁰⁰³⁵⁰^W^eaker^Yen^{$880 b}^illioⁿ⁾
³⁰⁰^Plaz^a
⁸⁰⁰^A^cco^r^d^Int^e^r-
²⁵⁰^S^t^ronge^{r Y}^eⁿ^veⁿ^tⁱ^oⁿ^Fina^nc^ia^l^Bubble^Burs^t
^Int^e^r-
⁶⁰⁰²⁰⁰^Int^e^r-^veⁿ^tⁱ^oⁿ^veⁿ^tⁱ^oⁿ
^Int^e^r-
^veⁿ^tⁱ^oⁿ
^Yen/Dollar
⁴⁰⁰¹⁵⁰^Exch^an^g^e^R^a^t^e
⁽^R^ight^A^x^is)
¹⁰⁰^Foreⁱ^{gn E}^x^c^h^a^nge
²⁰⁰^R^eser^v^{es M}ⁱⁿ^u^s^Go^ld^(Le^{ft A}^xⁱ^s⁾
⁵⁰^A^s^ia^{n Fina}^nc^ia^l^Crisis
⁰⁰
²³⁴⁷⁵⁶⁷⁸⁹⁸⁰¹²³⁴⁸⁵⁶⁷⁸⁹⁹⁰¹²³⁴⁹⁵⁶⁷⁸⁹⁰⁰⁰¹²³⁴⁵⁶
¹⁹⁷²
^Y^ear
^Sour^ce:^Dat^a^f^r^om^W^o^r^l^{d Bank.}^W^o^r^l^{d Dev}^e^l^opm^ent^I^ndi^cat^o^r^s
Even though Japan has invested hundreds of billions of dollars in buying dollar
assets that are then held as foreign exchange reserves, many observers point out that
such transactions are small when compared with the average daily turnover of $3.2
trillion in traditional foreign exchange markets and $2.4 trillion in over-the-counter
⁹ For data on intervention, see Japan. Ministry of Finance. International Reserves/Foreign
Currency Liquidity. Issued monthly. Also see Foreign Exchange Intervention Operations.
Issued periodically. See [http://www.mof.go.jp/english/files.htm].
¹⁰ Dominguez, Kathryn M. “Foreign Exchange Intervention: Did It Work in the 1990s?,”
In Dollar Overvaluation and the World Economy, edited by Fred Bergsten and John
Williamson, Washington, Institute for International Economics, 2003. pp. 217-245.

currency and interest rate derivatives markets.¹¹ Currency transactions in support of
imports and exports, investments, remittances, and other purposes dwarf
interventions by central banks. Still, it is the effect of central government
intervention on net — rather than gross — flows that make the difference (since
imports and exports tend to balance on a global basis). Government purchases and
sales constitute a net addition to or subtraction from global demand and supply. Also
government interventions can have a powerful signaling effect on market participants
who may prudently reduce their speculative buying should it be in a contrary
direction to what the government is doing. Central banks also often coordinate
intervention (intervening in the same direction the same day). This multiplies the
effect of the intervention.
Economic Studies
Academic studies of intervention generally conclude that interventions did
increase exchange rate volatility (moved the market), were a good indicator that the
magnitude of the change in exchange value on subsequent days would decrease, and
that much of it amounted to “leaning against the wind.”¹² A recent study of the 1991-
2002 period of Japanese intervention concluded that “prior to June 1995, Japanese
interventions only had value as a forecast that the previous day’s yen appreciation or
depreciation would moderate during the current day. After June 1995, Japanese
purchases of dollars had value as a forecast that the yen would depreciate” in the very
short run. This analysis also confirmed that large, infrequent interventions, which
characterized the latter period, had a higher likelihood of success than small, frequent
interventions. For 2003 and 2004, despite the record size and frequency of the
intervention by Japan, the authors found it difficult to statistically distinguish the
pattern of exchange rate movements on intervention days from that of all the days in
that particular subperiod. This showed little effectiveness in the interventions for that¹³
subperiod and only modest effectiveness overall.
Another study examining data from 1991 to 2000 found strong evidence that
“sterilized” intervention (buying of dollars offset by domestic selling of yen-
denominated bonds to keep Japan’s money supply unchanged) systemically affected
the exchange rate in the short-run (less than one month). Large-scale intervention
(amounts over $1 billion) — coordinated between the Bank of Japan and the U.S.
Federal Reserve — gave the highest success rates. Of the 12 “large scale
coordinated” interventions studied, 11 achieved the desired effect: they moved the

¹¹ Bank for International Settlements. Triennial Central Bank Survey of Foreign Exchange
and Derivatives Market Activity in April 2007, September 2007. pp. 1-5.
¹² Neely, Christopher J. An Analysis of Recent Studies of the Effect of Foreign Exchange
Intervention. The Federal Reserve Bank of St. Louis Working Paper 205-030B, Revised
June 2005. p. 3, 8ff.
¹³ Chaboud, Alain P. and Owen F. Humpage. “An Assessment of the Impact of Japanese
Foreign Exchange Intervention: 1991-2004.” Board of Governors of the Federal Reserve
System, International Finance Discussion Papers, No. 824, January 2005. p. 1-5.

yen either up or down in accordance with the policy goal of the moment, although the
effects were short-lived.¹⁴
The estimate that the yen was 10% to 20% undervalued is emphasized heavily
by U.S. automaker along with other industrial interests. In 2003, General Motors
claimed that the yen should be trading at about 100, rather than at 110 yen per
dollar.¹⁵ In late 2005, as the dollar strengthened, General Motors claimed that the
relatively weak yen (111 per dollar at the time) was providing a significant cost
advantage (about $3,000 per vehicle) to Japanese automakers. GM also raised the
issue of “jawboning” and verbal currency intervention (talking the yen down) by
high-ranking Japanese officials.¹⁶ In a meeting between President Bush and the Big
Three U.S. automakers, General Motors Chairman Rick Wagoner indicated there is
still a chasm between the auto industry and President Bush on foreign exchange
issues. Wagoner said the yen, in particular, was “systematically undervalued” with
the car companies estimating that Japanese competitors gain a $3,000 to $9,000 cost
advantage per vehicle over U.S. auto makers thanks to what is seen as an unfair
currency advantage.¹⁷ In April 2007, the Automotive Trade Policy Council (with
membership by Daimler Chrysler, Ford, and GM) claimed that Japan’s weak yen
policy had forced U.S. automakers to contend with a $4,000 subsidy on vehicles that
their Japanese competitors export from Japan to the United States.¹⁸
A leading proponent of the position that Japan has manipulated its exchange rate
is Ernest Preeg.¹⁹ In one study, he concluded that Japan had manipulated its
exchange rate and that the yen in 2002 was about 20% undervalued and should have
been around 100 yen per dollar.²⁰ His analysis is based on the observation that
Japan’s intervention has been large, protracted, and one-sided, but the 20% figure is
a rough estimate based primarily on the extent of the intervention, not on a rigorous
economic model.
The International Monetary Fund also conducts surveillance over the exchange
rates of its member countries. In the IMF’s August 2005 report on consultations with

¹⁴ Faum, Rasmus and Michael M. Hutchinson. “Effectiveness of Official Daily Foreign
Exchange Market Intervention Operations in Japan.” National Bureau of Economic
Research Working Paper 9648, April 2003. p. 1-5.
¹⁵ Meredith, Robyn. “GM: Weak Yen Hurts U.S. Automakers,” Forbes, October 21, 2003.
¹⁶ Mohatarem, Mustafa. Statement before the House Committee on Ways and Means,
Hearing on United States-Japan Economic and Trade Relations, September 28, 2005.
¹⁷ “Auto Makers Cite Open Dialogue With Bush Administration.” Dow Jones News
Service, November 14, 2006.
¹⁸ Automotive Trade Policy Council. U.S. Automakers Call on G7 to Address Imbalanced
Japanese Yen at Finance Ministers Meeting in Washington, News Release, April 12, 2007.
¹⁹ Ernest H. Preeg is a Senior Fellow in Trade and Productivity at the Manufacturers
Alliance/MAPI.
²⁰ Preeg, Ernest H. “Exchange Rate Manipulation to Gain an Unfair Competitive
Advantage: The Case Against Japan and China,” in C. Fred Bergsten and John Williamson,
Dollar Overvaluation and the World Economy, Washington, Institute for International
Economics, 2003. p. 273.

Japan, the Fund noted that compared to the United States and the Euro Area, Japan
stands out for its active use of foreign exchange market intervention as a policy
instrument. The IMF reported that since 1991, the Bank of Japan had intervened on
340 days, the European Central Bank on four days (since its inception in 1998), and
the U.S. Federal Reserve on 22 days. The IMF further stated that “there is some
evidence that intervention has had some impact on yen movements.” It then quoted
Takatoshi Ito, a Japanese economist, who found that intervention of about ¥2.5
trillion (about $250 billion) on average moved the exchange rate by ¥1 per dollar or
about 1%.²¹ The IMF’s May 2006 report on consultations with Japan did not discuss
exchange rate intervention.²²
A fundamental problem with exchange rates is that no commonly accepted
method exists to estimate the effectiveness of official intervention into foreign
exchange markets. Many interrelated factors affect the exchange rate at any given
time, and no quantitative model exists that is able to provide the magnitude of any
causal relationship between intervention and an exchange rate when so many
interdependent variables are acting simultaneously.²³
A 2007 Occasional Paper No. 7 by economists at the U.S. Treasury surveyed
exchange rate models and misalignments in currencies. The authors concluded that
currencies cannot be said to be misaligned without estimating what the exchange rate
should be. Economists use various models to estimate such hypothetical exchange
rates and then compare the modeled rates to the actual ones. The study notes that the
models produce widely divergent results and depend heavily on their assumptions,
methodologies, and mathematical structure in trying to capture all the relevant
features of an economy, particularly the behavior of financial markets. For Japan, the
authors note that according to the purchasing power parity approach, Japan’s
currency in 2003 was overvalued (not undervalued) by 21%. According to a Big Mac
index of the cost of this hamburger across countries, in May 2006, the yen at 112 yen
per dollar was 28% undervalued. Using relative labor costs to calculate real effective
exchange rates, in 2004, Japan’s yen was undervalued by 6.3%, but was overvalued
by 2.2% using relative consumer prices in the calculation. Private sector estimates
likewise vary widely. Using various methods, the Hong Kong and Shanghai Banking
Corporation (HSBC) estimated the yen to have been 1.8% overvalued at the end of

2005, while Goldman Sachs estimated that it was 6.9% undervalued, while J.P.

Morgan Stanley came up with the figure of 14% undervalued.²⁴ In 2007, Morgan

²¹ International Monetary Fund. IMF Country Report No. 05/273, Japan: 2005 Article IV
Consultation — Staff Report; Staff Supplement; and Public Information Notice on the
Executive Board Discussion. August 2005. Ito, Takatoshi. Interventions and the Japanese
Economic Recovery, paper presented at the University of Michigan Conference on Policy
Options for Japan and the United States. October 2004.
²² International Monetary Fund. Japan — 2006 Article IV Consultation, Concluding
Statement of the IMF Mission, May 24, 2006.
²³ See, for example, International Monetary Fund. IMF Country Report No. 05/273, Japan:
2005 Article IV Consultation — Staff Report; Staff Supplement; and Public Information
Notice on the Executive Board Discussion. August 2005. p. 7.
²⁴ McCown, T. Ashby, Patricia Pollard, and John Weeks. Equilibrium Exchange Rate
(continued...)

Stanley reported that the thirteen models it uses to value currencies provided
estimates of the exchange value of the yen being between 18% overvalued and 29%
undervalued with the median at 15% undervaluation.²⁵ These models do not,
however, differentiate between undervaluation caused by intervention and that caused
by market forces.
Setting aside the problems with statistical estimates, what can be said is that the
Japanese economy has generated a surplus in its trade accounts for much of recent
history. Without an offsetting deficit in its capital account, market forces would have
forced an appreciation of the yen that would have worked to eliminate the trade
surplus. From 1977 to 2004, Japan’s cumulative surplus on current account (net
trade in goods and services plus remittances) totaled $2,077 billion. Offsetting
Japan’s surplus on current account was its net capital outflow and net official
purchases of foreign exchange reserves (intervention). From 1977 to 2004, Japan
recorded a deficit in its capital flows (investments in foreign securities, buying
foreign companies, deposits in foreign bank accounts, etc.) of $1,314 billion. In
other words, Japan’s private investors sent $1,314 billion more abroad than
foreigners invested in Japan. The remaining $763 billion outflow ($2,077 billion
minus $1,314 billion) of dollars was primarily from official currency intervention
that added to Japan’s foreign exchange reserves. This net buying of $763 billion²⁶
in dollars — over the 1977-2004 period provided more than a third (37%) of the total
capital outflow from Japan to offset the country’s surplus in trade. If Japan had not
intervened to this extent, the yen likely would have appreciated more than it did.
Taking the estimate by Takatoshi Ito that $250 billion in intervention moved the
exchange rate by about 1% or ¥1, the net effect of the direct intervention that ended
in 2004 would have been around ¥3 or ¥4 per dollar. Taking the estimates by Preeg
and General Motors, the upper bound on the effect of the intervention would be
around 20% or about ¥20 per dollar. The range, therefore, for the effect of exchange
rate undervaluation because of Japanese intervention would be from ¥3 to ¥20 per
dollar with the statistical likelihood more toward the lower end of the range.
The Link Between Exchange Value and Trade
Setting aside the question of the efficacy of Japan’s intervention into exchange
markets to weaken the yen, a second question is whether changes in the yen-dollar
exchange rate actually affect imports and exports. In theory, Japan’s intervention by
buying dollars and selling yen induces a cheaper yen which then assists Japan’s
exporters by allowing them either to lower their export price or to maintain their

²⁴ (...continued)
Models and Misalignments. Department of the Treasury, Office of International Affairs,
Occasional Paper No. 7, March 2007.
²⁵ Finance and Economics: Misleading Misalignments; Economics Focus. The Economist,
June 23, 2007. P. 100.
²⁶ Japan’s holdings of foreign exchange reserves actually rose by $811 billion over this
period. Some of this may have been interest earned on its holdings.

export price while increasing profits. It also makes imports relatively more
expensive in Japan. Lowered export prices and higher import prices will tend to
increase Japan’s trade surplus which then contributes to a higher growth rate. The
Bank of Japan may or may not sterilize the currency operation by selling Japanese
bonds locally to keep the domestic money supply constant. In an economic sense,
if the intervention is not sterilized, buying dollars is equivalent to increasing the
Japanese money supply, since the Finance Ministry purchases the dollars from
Japanese exporters with yen which then enters the Japanese money supply.
In actual practice, the operation of currency markets often deviates from that
represented in economic theory and in models. In particular, the long-term link
between intervention and the foreign exchange rate is difficult to show empirically.
While the intervention has short-term effects, the long-term effects on exchange rates
and trade flows are much less apparent — especially considering that most of the
time, the intervention leans against the wind rather than reversing the direction of
change.
A second problem is that, in practice, Japan’s automakers and other exporters
to U.S. markets usually do not make short-run adjustments to prices in response to
exchange rate fluctuations. Unlike generic commodities (such as crude oil or wheat
that have standardized commodity markets), Japan’s exports tend to be brand-named
products for which the sellers have some control over prices. When selling in the
United States, dealers and retailers of products from Japan tend to “price to market”
or set prices according market conditions.²⁷
For instance, between January 5, 1994, and April 19, 1995, the Japanese yen
appreciated by 34% against the dollar (it rose from 113 to 80 yen per dollar). Prices
for exported products from Japan to the United States should have risen significantly,
but, for example, the U.S. sticker price of a Toyota Celica ST Coup rose by only 2%
(it went from $16,968 to $17,285), while the suggested retail price of a large-screen
Sony Trinitron television receiver actually fell by 15%. Japanese exporters simply
absorbed exchange rate changes into their costs. They tended to gain or lose profits
— rather than market share — because of exchange rate changes. In the case of
Toyota Motors, it is estimated that the company’s profit increases by ¥25 billion
($227 million) a year for every ¥1 the currency depreciates against the dollar.²⁸ For
shipments to the United States, economic studies have found that, on average, an
exchange rate change induces a price response equal to one-half the amount, although
it varies by industry.²⁹ An implication of this lack of a complete response of
domestic prices to exchange rate changes is that a currency depreciation will not
necessarily eliminate — or even reduce significantly — a nation’s trade deficit.

²⁷ Goldberg, Pinelopi Koujianou and Michael M. Knetter. Goods Prices and Exchange
Rates: What Have We Learned? Journal of Economic Literature, vol. 35, September 1997.
pp. 1244, 1270.
²⁸ “Toyota Hits Year’s High on Robust Car Sales, Weak Yen.” Nikkei Weekly, August 22,

2005. p. 27.

²⁹ Goldberg, Pinelopi Koujianou and Michael M. Knetter. “Goods Prices and Exchange
Rates: What Have We Learned?” Journal of Economic Literature, vol. 35, September 1997.
pp. 1244, 1270.

Empirical studies indicate, however, that for most countries over the long run,
a real depreciation (adjusting for domestic inflation) is likely to improve a nation’s
current account balance while a real appreciation is likely to worsen it. In the
short-run, however, the opposite is likely to occur. This is called the J-curve effect.
As the value of the yen rises, for example, some Japanese exporters do increase their
prices, and U.S. importers end up paying more for the quantity of goods they need.
This worsens the balance of trade before U.S. importers can switch to other
suppliers.³⁰
Still, Japan’s balance of trade does respond somewhat in the long run to a large
appreciation of the yen. Japanese exporters ultimately have to either raise prices or
decrease costs of production, and importers of commodities in Japan face lower
international prices. This works to reduce Japan’s surplus in trade (exports fall while
imports rise).
One economic study indicated that, in 2002, a 1% appreciation of the yen
induced a 2.2% decrease in Japan’s current account surplus (balance of trade with the
world in goods and services plus unilateral transfers).³¹ At that time, Japan’s current
account surplus was about $110 billion. Therefore, a 1% yen appreciation was
estimated to decrease Japan’s current account balance by about $2.4 billion. Another
study for 1985-1991 found that a 10% sustained appreciation of the yen would reduce
Japan’s trade surplus by 0.7% of gross national product (GNP).³² At that time,
Japan’s GNP was around $3,000 billion. A 1% appreciation of the yen, therefore,
would have reduced Japan’s trade surplus by about $2.1 billion.
In actuality, from 2002 to 2004, the yen appreciated from ¥120 to ¥104 per
dollar (up by 13%), but Japan’s current account surplus rose (not fell) from $113
billion to $172 billion (up by 52%).³³ Part of this rise in Japan’s current account
surplus may have been the J-curve effect, but in this case the yen appreciation was
overshadowed by other variables. Yen appreciation may have slowed the rise in
Japan’s current account surplus, but it did not stop it. Other factors also came into
play. These included growth in the American and other major markets, relative
savings and inflation rates, the level of interest rates in various markets, earnings
from investments, the competitiveness of Japanese products, the price of petroleum,
competition from China, and intra-firm trade by multinational corporations.

³⁰ In order for a real depreciation to improve the current account, exports and imports must
be sufficiently elastic respect to the real exchange rate. This condition holds for most
industrialized countries for trade in manufactured goods in the long run but not in the short
run. Krugman and Obstfeld, International Economics, pp. 450, 468.
³¹ Cline, William R. The Impact of US External Adjustment on Japan. In Dollar
Overvaluation and the World Economy, edited by C. Fred Bergsten and John Williamson.
Institute for International Economics, Washington, DC, 2003. pp. 190-91.
³² Yoshitomi, Masaru. Surprises and Lessons from Japanese External Adjustment in 1985-

91. In International Adjustment and Financing: The Lessons of 1985-1991, edited by C.

Fred Bergsten, Institute for International Economics, Washington, DC, 1991. pp. 128-29.
³³ Over the 2002-2004 period, differences in rates of inflation would have changed the real
exchange rate and real current account balance somewhat.

Another question is whether Japan’s intervention into foreign exchange markets
raised its rate of growth. Figure 4 shows Japan’s currency intervention in terms of
annual rates of change in its foreign exchange reserves and the yen/dollar exchange
rate. It also shows Japan’s economic growth rate (in real gross domestic product).
The chart indicates that many of the periods of yen appreciation and intervention into
foreign exchange markets to buy dollars also were periods of relatively slower — not
faster — economic growth rates. Except in the late 1970s, Japan’s growth
performance during periods of intervention was rather lackluster. Growth tended to
be higher during periods without intervention, although it can be argued that the
intervention may have helped to keep economic conditions from becoming worse
than they actually were.
Figure 4. Changes in Japan’s Foreign Exchange Reserves and
in the Yen/Dollar Exchange rate with Interventions and GDP
Growth Rates, 1972-2006

¹⁰⁰^A^{nnual P}^e^rc^ent^Change¹⁰⁰^S^t^r^onger^Yen^In^t^e^r^-
^ve^ntⁱ^oⁿ
⁸⁰⁸⁰
⁶⁰⁶⁰^GDP^Gr^owth^Ra^t^e^In^t^e^r^-^In^t^e^r^-^In^t^e^r^-
^ve^ntⁱ^oⁿ^ve^ntⁱ^oⁿ^ve^ntⁱ^oⁿ
⁴⁰⁴⁰
²⁰²⁰
⁰⁰
^-20^-20
^Ch^an^g^eⁱⁿ^Do^llar^s^/Y^en
^-40^-40^C^h^{ange in For}^{eign E}^{xchange R}^eser^v^e^s
^-60^-60
²³⁴⁷⁵⁶⁷⁸⁹⁸⁰¹²³⁴⁸⁵⁶⁷⁸⁹⁹⁰¹²³⁴⁹⁵⁶⁷⁸⁹⁰⁰⁰¹²³⁴⁵⁶
¹⁹⁷²
^Y^ear
^S^{ource: U}^nderl^yⁱ^{ng data from}^W^o^rl^{d B}^{ank. W}^o^rl^{d D}^e^vel^opm^{ent Indi}^cators
Intervention or Manipulation?
A question for U.S. policy is whether Japan’s intervention into currency markets
constituted manipulation of its exchange rate. Under U.S. law, the Secretary of the
Treasury is required to analyze the exchange rate policies of foreign countries
annually (in consultation with the International Monetary Fund) and consider whether
countries manipulate their exchange rate for purposes of preventing effective balance
of payments adjustment or gaining unfair competitive advantage in international
trade. If the Secretary considers that such manipulation is occurring with respect to
countries that (1) have material global current account surpluses; and (2) have
significant bilateral trade surpluses with the United States, the Secretary of the
Treasury shall take action to initiate negotiations with such foreign countries on an

expedited basis, in the International Monetary Fund or bilaterally, for the purpose of
ensuring that such countries regularly and promptly adjust the rate of exchange
between their currencies and the United States dollar to permit effective balance of
payment adjustments and to eliminate the unfair advantage. The Secretary of the
Treasury also is to provide reports on exchange rate policy that contain the results of
exchange rate negotiations conducted pursuant to this law.³⁴
At various periods from 1988 through 1994, Treasury found that China, Taiwan,
and South Korea were each considered to have manipulated their currencies.³⁵ In the
March and November 2005 and May 2006 reports to Congress as required by the
Omnibus Trade and Competitiveness Act of 1988, Treasury indicated that it had
reviewed the exchange rates, external balances, foreign exchange reserve
accumulation, macroeconomic trends, monetary and financial developments, state of
institutional development, and financial and exchange restrictions for U.S. trading
partners. In both reports, Treasury did not find currency manipulation by any
country, including by Japan.³⁶ Likewise, in Treasury’s December 2006 report to
Congress, the Secretary stated that persistent Japanese deflation since 1998 has led
to a substantial depreciation of the yen in real terms. Bank of Japan data indicate that
the yen was at its weakest level in real trade-weighted terms in more than 20 years,
even though Japanese authorities had not intervened in the foreign exchange market
since March 2004.³⁷
In April 2005, the Government Accountability Office examined Treasury’s
assessments of whether countries were manipulating their currencies and concluded
that “although China and Japan have engaged in economic activities that have led to
concerns about currency manipulation,” Treasury “did not find that Japan met the
Trade Act’s definition for currency manipulation in 2003 and 2004.” GAO reported
that Treasury viewed “Japan’s exchange rate interventions as part of a macro-
economic policy aimed at combating deflation....”³⁸
In September 2005 testimony before the House Ways and Means Committee,
Deputy Assistant Secretary of the Treasury David Loevinge stated that Treasury had

³⁴ 22 U.S.C. §5304-5305.
³⁵ Treasury considered the following countries to be manipulating their exchange rates under
22 U.S.C. 5304: Oct 1988 Report — Korea and Taiwan; April 1989 Report — Korea and
Taiwan; October 1989 Report — Korea, May 1992 Report — China and Taiwan; December

1992 Report — China and Taiwan; May 1993 Report — China; November 1993 Report —

China; July 1994 Report — China.
³⁶ U.S. Department of the Treasury. Report to the Committees on Appropriations on
Clarification of Statutory Provisions Addressing Currency Manipulation. Press Release
js2308, May 25, 2005. p. 4. Report to Congress on International Economic and Exchange
Rate Policies, November 2005.
³⁷ U.S. Secretary of the Treasury. Report to Congress on International Economic and
Exchange Rate Policies. December 2006. p. 23.
³⁸ United States Government Accountability Office. Treasury Assessments Have Not Found
Currency Manipulation, but Concerns about Exchange Rates Continue. GAO Report GAO-

05-351, April 2005. p. 4.

discussed foreign exchange market issues with Japanese officials. He stated that
Japan has supported the G-7 position on exchange rates, expressed in a series of G-7
Communiqués, calling for greater exchange rate flexibility. Japan also has worked
with the United States to bring about greater exchange rate flexibility in China and
in other large economies in East Asia.³⁹
The International Monetary Fund also conducts surveillance over the exchange
rates of its member countries. A 1977 decision by the Fund (as amended), a principle
for guidance of member’s exchange rate policies states, “A member shall avoid
manipulating exchange rates or the international monetary system in order to prevent
effective balance of payments adjustment or to gain unfair competitive advantage
over other members.” The decision, does allow, however, for governments to
intervene in the exchange market if necessary to counter disorderly conditions
(disruptive short-term movements in the exchange value of its currency).⁴⁰ In the
IMF’s August 2005 report on consultations with Japan, the Fund did not find
currency manipulation, but noted that compared to the United States and the Euro
Area, Japan stands out for its active use of foreign exchange market intervention as
a policy instrument.⁴¹
As a comparison, one can compare the movement of the exchange rate between
the German mark and the dollar with that for the yen and the dollar. Figure 5 shows
the movement of indexes (1972 = 100) for the value of the two exchange rates. From
1972 to 2005, the yen has appreciated more than the mark, and they generally have
moved together. The correlation coefficient between the two indexes is 0.82 (they
move together 82% of the time). From 1993, the Euro replaced the country
currencies of the members of the European Union, and the index of its value replaces
that of the German mark. In Figure 5, the Euro index is set at 100 in January 1993.
As can be seen, the index of the Euro also has moved roughly with the yen with the
exception of the U.S. recession period around 2001 when the dollar rose in value
relative to the Euro and mark but rose less relative to the yen. Most of the time,
however, the values of these currencies seemed to be responding to the same outside
influences.

³⁹ U.S. Department of the Treasury. Testimony of Deputy Assistant Secretary of the
Treasury David Loevinger before the House Ways and Means Committee, JS-2954,
September 28, 2005.
⁴⁰ International Monetary Fund. Surveillance Over Exchange Rate Policies, Decision No.

5392-(77/63), April 29, 1977 as amended.

⁴¹ International Monetary Fund. IMF Country Report No. 05/273, Japan: 2005 Article IV
Consultation — Staff Report; Staff Supplement; and Public Information Notice on the
Executive Board Discussion. August 2005.

Figure 5. Indexes of the Value of the Japanese Yen, German Mark,
and European Union Euro per U.S. Dollar

^Index^of^Cur^r^enc^y^{Value in $}
¹⁶⁰
¹⁴⁰
^S^t^ronge^{r Dol}^l^a^{r &}^Eu^ro
^{Weaker Yen}^/^M^a^rk/Eu^r^o
¹²⁰
^Yen
¹⁰⁰
^Ma^r^k
⁸⁰
⁶⁰
⁴⁰^{Weaker D}^o^{llar &}^S^t^ronge^{r Y}^e^n/^Ma^rk^/^E^uro
²⁰
⁰
⁷²⁷³⁷⁴⁷⁵⁷⁶⁷⁷⁷⁸⁷⁹⁸⁰⁸¹⁸²⁸³⁸⁴⁸⁵⁸⁶⁸⁷⁸⁸⁸⁹⁹⁰⁹¹⁹²⁹³⁹⁴⁹⁵⁹⁶⁹⁷⁹⁸⁹⁹⁰⁰⁰¹²³⁴⁵⁶⁷
²
^{End of}^Y^ear
^N^o^{te: J}^anuar^y^{1972 =}^{100 for}^Y^{en and M}^a^r^k^{. J}^anuar^y¹⁹⁹³⁼^{100 for}^Eur^o^{. U}^nder^l^yⁱ^{ng ex}^c^{hange r}^a^t
^fr^om^PAC^IF^IC^Ex^c^{hange R}^a^{te Ser}^vⁱ^c^e.
Policy Issues
Even though Japan indicates that it has not intervened into currency markets
since March 2004, this issue still is a U.S. policy concern because of Tokyo’s past
intervention and the possibility that it could resume intervening should the yen
strengthen too rapidly or excessively against the dollar. Japan also may use other
methods to alter the expectations of currency traders and “talk down” the yen through
various statements or other “jawboning.” Japan also could be caught up in the
concern over China’s currency policy. Policies aimed at China also could affect
Japan. Currently, Tokyo seems content to abstain from active intervention into
international currency markets. At some point, however, Japan may want to decrease
its dollar denominated foreign exchange holdings. It would likely do this by selling
dollar-denominated assets, an action that would weaken the dollar and strengthen the
yen. Depending on how this potential divestiture is conducted, it could be viewed
as intervention into foreign exchange markets (albeit in the opposite direction of
concern). Given the weakness of the dollar in 2008, moreover, if the value of the yen
“overshoots” and rises to a value considered to be too high for Japanese financial
authorities, they may be compelled by political pressures from their exporting
industries to intervene. According to observers, the threshold exchange rate at which
Japan may intervene seems to be around 85 to 90 yen per dollar. Ironically,

intervention under current circumstances to strengthen the weakened dollar, may
coincide with U.S. economic policy goals.⁴²
A question remains, moreover, whether the United States should take measures
to compensate for past intervention by Japan. Setting aside the issue of how much
past intervention actually moved the exchange rate and whether any exchange rate
change affected actual market transactions, if U.S. industries were significantly
impacted negatively, should remedial action be taken now? If, for example, the U.S.
automobile industry lost market share because of past Japanese government attempts
to reduce the value of the yen, is there action that should be taken now to remedy the
lost market share?
The major policy options for Congress include the following:
^!let the market adjust (do nothing);
^!clarify the definition of currency manipulation;
^!require reports and negotiations;
^!require the President to certify which countries are manipulating
their currencies and take remedial action if the manipulation is not
halted; and
^!convene a special meeting of the International Monetary Fund to
reach an agreement on the misalignment of the yen, oppose
increased voting shares or representation in international financial
organizations for any country that has a currency that is manipulated
or in fundamental misalignment, initiate a dispute settlement case
with the World Trade Organization (WTO), or block the Overseas
Private Investment Corporation from providing services to Japan.
Let the Market Adjust (Do Nothing)
Most economists argue that currency markets are so large that only extensive
and coordinated intervention has any lasting effects. Countries that do intervene
often find themselves “leaning against the wind” and not materially altering either the
direction of or the extent of change. Also, intervention is expensive. It is not clear
that Japan could afford to invest another $800 billion in U.S. Treasury securities and
other liquid dollar assets. Allowing market forces to determine exchange rates while
permitting central banks to intervene only to counter abnormal market shifts is the
policy pursued for most major currencies of the world.
In terms of foreign exchange intervention, Japan differs from China in two
important respects. First, Japan does not peg its exchange rate to any basket of

⁴² Since the Federal Reserve has been lowering interest rates to stimulate the U.S. economy
and shore up the financial sector, foreign investors are seeking higher returns elsewhere and
less capital appears to be flowing into the United States. This has caused the value of the
dollar to decline and prices of imported products (especially energy) to rise. This, in turn,
raises the rate of inflation in the United States. If the Federal Reserve wants to increase
inflows of capital, it may need an outside policy instrument (intervention by Japan), since
it is not able to induce greater capital inflows without raising interest rates and impairing its
other policy actions.

currency. It generally intervenes to slow down rates of change not to maintain a
certain exchange rate. It also does not require citizens to sell foreign exchange to the
central bank at an official rate of exchange. Second, Japan allows for free flows of
capital into and out of the country. This makes currency manipulation much more
difficult in Japan, since speculators and investors can offset official buying and
selling of foreign financial assets.
A currency peg without capital controls is expensive and difficult to maintain
during a financial crisis. During the 1997-1998 Asian financial crisis, for example,
Hong Kong maintained its pegged exchange rate partly by raising domestic interest
rates to attract foreign capital and to retard capital flight by local investors (to reduce
the incentive to convert Hong Kong dollars to U.S. dollars in anticipation of a drop
in the value of the Hong Kong dollar). On October 23, 1997, the overnight rate of
interest in Hong Kong jumped from 6.25% to 100.0% as the monetary authorities
tried to stem the capital outflow. Even though Hong Kong was able to maintain its
exchange rate peg, the high interest rates caused a near collapse of real estate markets
there. This is one reason China still maintains some capital controls.⁴³ Since the
Asian financial crisis, Japan and other Asian nations have negotiated currency swap
agreements to provide short-term sources of foreign exchange in times of crisis.⁴⁴
This obviates, somewhat, the need to rely on interest rates to attract foreign capital.
Under a policy of allowing market forces to determine exchange rates, some
intervention still may be necessary to calm excessive volatility in markets or to
counter trends that overshoot because of herd mentality and other effects. In the past,
the more successful of such interventions were coordinated among the large,
industrialized nations.
Clarify the Definition of Currency Manipulation
A major provision of various currency bills in Congress has been to clarify the
definition of currency manipulation. While this legislation apparently has been
aimed primarily at China’s currency policy, in cases, the bills also have cited Japan
(and South Korea) in the findings.
Currently, the Department of the Treasury, in consultation with the International
Monetary Fund, determines each year whether countries are manipulating their
exchange rate for purposes of gaining an unfair trade advantage or preventing
effective balance of payments adjustments and also have a material global current
account surplus and a significant bilateral trade surplus with the United States.⁴⁵

⁴³ For financial data, see Global Financial Data at [http://www.globalfinancialdata.com].
⁴⁴ This is called the Chiang Mai Initiative. See Seok-Dong Wang and Lene Andersen.
“Regional Financial Cooperation in East Asia: the Chiang Mai Initiative and Beyond,”
UNESCAP Bulletin on Asia-Pacific Perspectives 2002/03, Chapter 8.
⁴⁵ Omnibus Trade and Competitiveness Act of 1988, 22 U.S.C. § 5304(b), § 3004(b) . The
global current account surplus is the current account surplus of merchandise, services, and
transfers with all other countries, while the bilateral trade surplus is the surplus in goods and
services trade with one trading partner country only.

H.R. 1498 (Ryan)/S. 796 (Bunning) and H.R. 2886 (Knollenberg)/S.
1021(Stabenow) define exchange-rate misalignment as an undervaluation of a foreign
currency (yen) as a result of protracted large-scale intervention by or at the direction
of a governmental authority in the exchange market. Such undervaluation shall be
found when the observed exchange rate for a foreign currency (yen) is below the
exchange rate that could reasonably be expected for that foreign currency absent the
intervention. In determining whether exchange-rate misalignment is occurring and
a benefit thereby is conferred, the administering authority in each case would
consider an exporting country’s:
^!bilateral balance of trade surplus or deficit with the United States,
^!balance of trade surplus or deficit with other trading partners,
^!foreign direct investment in its territory,
^!currency specific and aggregate amounts of foreign currency
reserves,
^!mechanisms employed to maintain its currency at a fixed exchange
rate and the nature, duration, and monetary expenditures of those
mechanisms, and
^!may consider such other economic factors as are relevant.
S. 1607 (Baucus) would define a currency for priority action if the country that
issues such currency is:
^!engaging in protracted large-scale intervention in one direction in the
currency exchange market;
^!engaging in excessive reserve accumulation;
^!introducing or substantially modifying for balance of payments
purposes a restriction on, or incentive for, the inflow or outflow of
capital, that is inconsistent with the goal of achieving full currency
convertibility; or
^!pursuing any other policy or action that, in the view of the Secretary
of the Treasury warrants designation for priority action.
The bills also specify that trade data are to be those of the United States and
other trading partners of the exporting country, unless such trade data are not
available or are demonstrably inaccurate, in which case the exporting country’s trade
data may be relied upon if shown to be sufficiently accurate and trustworthy.
The issue of which data to use applies primarily to China, mainly because of
imports and exports that flow through, but do not originate in, Hong Kong and the
general lack of confidence in China’s system for compiling statistics and reporting
them. The data problem, however, also arises with Japan. In 2004 for Japan,
Japanese data (as accessed through the IMF or Global Trade Atlas⁴⁶) reported a
merchandise trade surplus of $110 billion (2.4% of GDP), but a compilation of

⁴⁶ The Japanese government reports trade data in yen values. They convert those data into
dollars when reporting them to the IMF. Global Trade Atlas is a propriety database of trade
statistics.

partner country data (statistics from countries that export to and import from Japan)
showed a surplus for that year of $208 billion (4.5% of GDP).⁴⁷
Each bill placed more emphasis on large-scale intervention by a country into
currency markets — particularly when evidenced by large accumulations of foreign
exchange. Such accumulations of dollars, do not constitute prima facie evidence of
currency manipulation, but they would be used along with other criteria to determine
whether a country has been engaged in it.
The bills have not addressed the issue of sterilization in currency intervention.⁴⁸
In 2003 and 2004, Treasury found that Japan did not meet the criteria for currency
manipulation in part because its exchange rate interventions were considered to be
part of a macroeconomic policy to combat deflation.⁴⁹ (It was considered to be
unsterilized intervention to increase the money supply.) A policy question is whether
large-scale interventions are justified when part of macroeconomic policy even
though they may have adverse affects on exchange markets.
Require Negotiations and Reports
Current trade law requires the President to seek to confer and negotiate with
other countries to achieve:
^!more appropriate and sustainable levels of trade and current account
balances and exchange rates of the dollar and other currencies
consistent with such balances; and
^!improvement in the functioning of the exchange rate system to
provide for long-term exchange rate stability consistent with more
appropriate and sustainable current account balances.⁵⁰
The United States and Japan also conduct regular cabinet and sub-cabinet
meetings that provide a venue to discuss exchange rates. In addition, the two
countries meet in G-7 summits and at the APEC (Asia Pacific economic cooperation)

⁴⁷ Data from International Monetary Fund. Direction of Trade Statistics. September 2005.
For 2004, China reported a merchandise trade surplus of $32 billion, but the exports and
imports of trading partners implied a trade surplus of $314 billion. The IMF notes that data
reported by exporting and importing countries can be inconsistent because of differences in
country of origin or destination classification concepts, lack of destination detail, time of
recording, valuation, coverage, and processing errors.
⁴⁸ Sterilized intervention refers, in the government of Japan’s case, to the buying of dollars
(or other foreign exchange) from Japanese holders and using those dollars to buy dollar-
denominated securities in the United States while simultaneously selling yen-denominated
securities in Japan to keep the domestic money supply unchanged.
⁴⁹ United States Government Accountability Office. Treasury Assessments Have Not Found
Currency Manipulation, but Concerns about Exchange Rates Continue. GAO Report
GAO-05-351, April 2005. p. 4.
⁵⁰ 22 U.S.C. § 5304.

meetings where currency and exchange rate policy is discussed.⁵¹ In a 2000 G-7
meeting, for example, the communique stated that the group had discussed
developments in exchange and financial markets and said that they welcomed the
reaffirmation by the Japanese monetary authorities that exchange rate policies would
be conducted appropriately in view of their potential impact and that they would
continue to monitor developments in exchange markets and cooperate as
appropriate.⁵²
Current bills related to Japan’s currency in the 110^th Congress would require
Treasury to submit a semi-annual report to Congress on currency intervention by
Japan to include any effort by Japan to create an exchange-rate misalignment
(including intervention and statements by Japanese government officials). The bills
also would require Treasury to submit to Congress a proposal for a comprehensive
joint U.S.-European Union plan to address the exchange-rate misalignment of the
Japanese yen. It also would require the U.S. government to initiate consultations
with Japan for the purpose of decreasing the foreign currency holdings of the
government of Japan.
Certify Currency Manipulation and Take Remedial Action
In the 110^th Congress, H.R.782 (Tim Ryan)/S.796 (Bunning) would make
exchange rate “misalignment” actionable under U.S. countervailing duty laws,
require the Treasury Department to determine whether a currency is misaligned in its
semi-annual reports to Congress on exchange rates.⁵³ This certification could then
trigger certain remedial actions under U.S. trade law. S.1677 (Dodd) would require
the Treasury Department to identify countries that manipulate their currencies
regardless of their intent and to submit an action plan for ending the manipulation.
It also would give Treasury the authority to file a case in the WTO.
Actions with the IMF, World Bank, WTO, and OPIC
The currency bills in the 110^th Congress also would require the Secretary of the
Treasury to oppose any change in the governance arrangements in International
Financial Institutions (such as the International Monetary Fund or World Bank) in the
form of increased voting shares or representation if the beneficiary country has a
currency that is manipulated or in fundamental misalignment.
S. 1677 (Dodd) would give the Treasury Department the authority to take a
currency manipulation case to the World Trade Organization through its dispute
settlement mechanism or to the International Monetary Fund.

⁵¹ See, for example: U.S. Department of the Treasury. Statement of G-7 Finance Ministers
and Central Bank Governors. September 25, 1999. Washington, DC.
⁵² Statement of G-7 Finance Ministers and Central Bank Governors. January 22, 2000.
Tokyo, Japan.
⁵³ The certification also can be that a country is not engaged in currency manipulation.

S. 1607 (Baucus) would require the United States to inform the International
Monetary Fund of the failure of a country to adopt appropriate policies to eliminate
the fundamental misalignment in its currency and request a consultation by the IMF
with that country. The United States also would not approve any new financing by
the U.S. Overseas Private Investment Corporation (including insurance, reinsurance,
or guarantee) and oppose any loan to the country from a multilateral bank. In the
case of a persistent failure to adopt appropriate policies to correct the misalignment,
the U.S. Trade Representative would request dispute settlement consultations at the
WTO.
With respect to the WTO dispute settlement mechanism, an agreement between
the IMF and WTO requires the WTO to refer exchange rate disputes to the IMF and
accept the IMF’s findings as conclusive. If the IMF finds currency manipulation, it
is not clear how a WTO dispute settlement panel would rule. There is no precedent
for a case in which currency manipulation is considered to have the effect of an
export subsidy and allows for direct retaliation against the exports of the offending
country.
Even though the IMF has not found that Japan was manipulating its currency
during its Article IV consultations, the United States could inform the IMF that it
believes Japan is not complying with the requirements of Article IV. This would
trigger consultations with Tokyo and a report by the Managing Director to the IMF’s
executive board.⁵⁴ While the IMF still might not find Japan guilty of currency
manipulation, it would put pressure on the Bank of Japan not to intervene in currency
markets in the future.
Legislation
Legislation in the 110^th Congress related to Japan’s⁵⁵ currency include the
following:
H.R. 782 (Ryan)/S. 796 (Bunning). Fair Currency Act of 2007. Would provide that
exchange-rate misalignment by any foreign nation is a countervailable export
subsidy and clarify the definition of manipulation with respect to currency.
H.R. 2886 (Knollenberg)/S. 1021 (Stabenow). Japan Currency Manipulation Act.
Would address the exchange-rate misalignment of the Japanese yen with respect
to the United States dollar.
S. 1607 (Baucus). Currency Exchange Rate Oversight Reform Act of 2007. Would
require the Treasury Department to identify currencies that are fundamentally

⁵⁴ For detail, see CRS Report RS22658, Currency Manipulation: The IMF and WTO, by
Jonathan E. Sanford.
⁵⁵ For analysis of policy with respect to China’s exchange rate, see CRS Report RL33536,
China-U.S. Trade Issues, by Wayne M. Morrison and CRS Report RS21625, China’s
Currency Peg: A Summary of the Economic Issues, by Wayne M. Morrison and Marc
Labonte.

misaligned and would require action to correct the misalignment. Such action
would include factoring currency undervaluation in U.S. anti-dumping cases,
banning federal procurement of products or services from the designated
country, and filing a case against in the WTO.
S. 1677 (Dodd). Currency Reform and Financial Markets Access Act of 2007.
Would require the Treasury Department to identify countries that manipulate
their currencies regardless of their intent and to submit an action plan for ending
the manipulation, and would give Treasury the authority to file a case in the
WTO.

Appendix
Japan’s GDP Growth Rate, Yen/Dollar Exchange Rate, and
Foreign Exchange Reserves, 1970-2008
GDP Foreign Exchange
YearGrowth Rate (%)Exchange RateReserves (US$)
1970 10.7 360.0 4,307,530,000
1971 4.7 350.7 14,621,900,000
1972 8.4 303.2 17,563,610,000
1973 8.0 271.7 11,354,560,000
1974 -1.2 292.1 12,614,290,000
1975 3.1 296.8 11,950,210,000
1976 4.0 296.6 15,746,250,000
1977 4.4 268.5 22,340,960,000
1978 5.3 210.4 32,407,240,000
1979 5.5 219.1 19,521,520,000
1980 2.8 226.7 24,636,450,000
1981 2.9 220.5 28,208,420,000
1982 2.8 249.1 23,333,970,000
1983 1.6 237.5 24,601,580,000
1984 3.1 237.5 26,429,150,000
1985 5.1 238.5 26,718,650,000
1986 3.0 168.5 42,256,600,000
1987 3.8 144.6 80,972,870,000
1988 6.8 128.2 96,728,190,000
1989 5.3 138.0 83,957,350,000
1990 5.2 144.8 78,500,590,000
1991 3.4 134.7 72,058,840,000
1992 1.0 126.7 71,622,670,000
1993 0.2 111.2 98,524,340,000
1994 1.1 102.2 125,860,200,000
1995 1.9 94.1 183,249,800,000
1996 3.4 108.8 216,648,000,000
1997 1.9 121.0 219,648,300,000
1998 -1.1 130.9 215,470,700,000
1999 0.1 113.9 286,916,100,000
2000 2.8 107.8 354,902,100,000
2001 0.4 121.5 395,155,000,000
2002 -0.4 125.4 461,185,600,000
2003 1.4 115.9 663,289,100,000
2004 2.7 103.8 833,891,000,000
2005 1.9 118.5 834,275,000,000
20062.2 116.3 874,596,000,000
20072.1 117.8947,987,000,000
March 20081.5 About 100 979,196,000,000
^Source:^Worl^{d Ban}^k^.^Worl^{d D}^e^v^e^l^opm^en^t^In^di^cat^ors^.^G^l^obal^In^sⁱ^g^h^t^{. Japan}^Miⁿⁱ^s^t^ry^of^Fⁱⁿ^aⁿ^ce.
^No^te:^T^h^e^gr^o^w^t^h^r^a^t^eⁱ^s^t^h^e^a^nnua^l^c^h^a^ngeⁱⁿ^r^e^a^l^gr^o^{ss d}^o^m^e^s^tⁱ^c^p^r^o^d^u^c^t^.^T^h^e^e^x^c^h^a^nge^r^a^t^eⁱ^s^y^eⁿ
^{per U.S. dollar, period av}^erag^{e. Foreig}ⁿ^ex^ch^an^g^e^R^e^s^e^rv^es^{are of}^fⁱ^{cial res}^e^rv^es^ex^clu^dⁱⁿ^g^g^o^ld.