Japan may help U.S. if China stops debt purchase

Japan may help U.S.
if China stops debt purchase

By Nick Olivari

guardian.co.uk
Reuters,
Tuesday January 27 2009

NEW YORK, Jan 27 (Reuters) - Japan could be a counterweight against rising U.S. borrowing costs should China buy less U.S. government debt in response to pressure from Washington to change its currency policy.

Investors are on full alert that Japan's Ministry of Finance could buy dollars to bring the yen down from a 13-1/2- year peak first touched in December and hit again in January.

Japan, which relies heavily on trade to power its economy, saw its exports plunge 35 percent in December.

Already holding $1.03 trillion in official reserve assets, according to International Monetary Fund data, the next question is what would Japan do with intervention dollars.

Given Japan is the second-biggest holder of U.S. debt after China, it would likely buy Treasuries, denting some of the impact if Beijing hits back over recent foreign-exchange criticism by Timothy Geithner, now Treasury secretary.

"Japan gets a higher dollar/yen rate and keeps the domestic exporters happy while the increased supply of U.S. debt and specifically Treasuries gets mopped up," said Dustin Reid, senior currency strategist at RBS Global Banking & Markets, in Chicago.

The U.S. government "could issue a lot more debt and it is no secret that Japan wants its currency to weaken," Reid said.

Prices of U.S. Treasury bonds fell last week, partly on concerns that Geithner's comments, made in testimony to senators weighing his nomination as Treasury secretary, could provoke China into buying less U.S. debt.

But there was no sign of weaker foreign demand at a $40 billion auction of two-year Treasury notes on Tuesday.

JAPAN'S INCENTIVE

Foreign central banks and individuals hold more than half of the $5.8 trillion in outstanding U.S. government debt. China and Japan hold about a quarter of the total amount.

China edged out Japan as the biggest holder of U.S. debt in 2008 after years of recycling the money they received from U.S. consumers for exports by buying Treasuries. That began a cycle of keeping the U.S. consumer at the mall on cheap loans.

Amid the global downturn, Japan has no less incentive to keep its factories running.

With the U.S. government set to issue some $2 trillion of debt in 2009 alone in order to fund a stimulus package to revive the economy, Washington is keen to see buyers.

"Intervention by Japan would probably result in increased purchases of U.S. debt," said Omer Esiner, senior market analyst at Ruesch International in Washington.

"Any decrease in demand for U.S. debt by China that is offset by Japan would be good for the U.S. economy."

Shortly before Geithner won confirmation as U.S. Treasury secretary on Monday, the White House hedged his statement last week -- that President Barack Obama believed China was manipulating its currency -- by saying a formal decision on the issue would be made in coming months.

The fear, though, is that this could be an opening salvo in a more confrontational relationship between the United States and China.

China has denied the currency manipulation charge, but IMF Managing Director Dominique Strauss-Kahn said on Monday the yuan was "significantly undervalued."

YUAN VS YEN

In the first three years after China let it begin to appreciate in July 2005 in response to long criticism from U.S. lawmakers, the yuan gained around 18 percent against the U.S. currency, including the initial revaluation.

But today, it is trading at 6.83 yuan to the dollar, kept by Chinese authorities at roughly where it was in July 2008.

At those levels, China has sold vastly more goods to the United States than the latter has sold to China. While China does have a cheap labor force, its trade advantage over other low-cost producers is bolstered by the exchange rate.

Between January and November 2008, the United States ran a trade gap with China of $246.45 billion, according to U.S. data, after a $256.2 billion deficit in 2007 as a a whole.

By contrast, the U.S. deficit with Japan was $67.39 billion for the first 11 months of 2008, after an $82.76 billion deficit in 2007. The freely floated yen last traded around 89.50 yen to the dollar.

Intervention by Japan's Ministry of Finance to weaken the yen by buying dollars could also be considered a "manipulation" of the currency, but Washington will point no fingers there, given the fundamentally different relationship with Japan.

"Japan does have a floating currency and they never (intervene) without alerting the Fed," said Peter Zeihan, vice president of analysis at Stratfor, an Austin, Texas-based global intelligence company. "Independent of that, Japan is an ally."

To be sure, whether the United States and China clash outright is still open to debate, as is whether Japan would even be able to press an advantage.

While Japan would probably like the dollar/yen rate to be above 100 instead of the current 89.14, the impact of China not buying U.S. Treasuries or moving reserves into other currencies could overwhelm any other actions, said Joseph Trevisani, chief market analyst at Saddle River, New-Jersey based FX Solutions.

"I'm not sure we would get the type of logical follow-up effects because of the turmoil," Trevisani said. "Fear for the U.S. economy could overwhelm the dollar and it would fall." (Reporting by Nick Olivari; Editing by Jan Paschal)

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