The Japanese Yen as an International Currency
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

The role of the Japanese yen as an international currency is assessed. It is found that the determinants of international-currency use imply some increase for the yen’s use in international finance; however, the implications for the yen’s use in international trade are mixed. It is also shown that, despite Japan’s emergence as the world’s largest net creditor nation, Japan’s capital outflows have not significantly facilitated the yen’s internationalization. Data are presented showing that, although the yen’s use as an international currency has increased, it is still rather modest. Wider use of the yen as a regional currency in Asia has occurred, though a “yen-zone” does not appear to be emerging.

Abstract

The role of the Japanese yen as an international currency is assessed. It is found that the determinants of international-currency use imply some increase for the yen’s use in international finance; however, the implications for the yen’s use in international trade are mixed. It is also shown that, despite Japan’s emergence as the world’s largest net creditor nation, Japan’s capital outflows have not significantly facilitated the yen’s internationalization. Data are presented showing that, although the yen’s use as an international currency has increased, it is still rather modest. Wider use of the yen as a regional currency in Asia has occurred, though a “yen-zone” does not appear to be emerging.

I. Introduction

In recent years there has been considerable interest in the possibility that a tripolar international monetary system, centered on the U.S. dollar, the deutsche mark and the Japanese yen, is emerging. In this regard, a number of studies dealing with the use of the Japanese yen as an international currency have appeared; however, in the main, these studies have considered the yen’s international use as a subsidiary component of another subject of inquiry. For example, Argy (1987), Thorn (1987), and Osugi (1990) briefly discuss the international use of the yen in the context of recent financial market deregulation in Japan. None of the studies has furnished a thorough analysis of the determinants of the yen’s international use. 1/

The purpose of this paper is to provide a more comprehensive account of the use of the Japanese yen as an international currency. The paper is divided into six sections, including this introduction. Section II briefly discusses the necessary conditions underlying international currency use. Section III describes the evolution of those factors as they relate to the Japanese yen. Section IV deals with the relationship between Japan’s external accounts—including its status as the world’s largest net creditor—and the international use of the yen. The section shows how, given the existence of the necessary conditions for international currency use, the direction, composition, and magnitude of a nation’s capital outflows can shed light on the processes through which international currencies emerge. The section also presents data suggesting that, although Japanese capital outflows have been large, their direction and composition have not been very conducive to the yen’s international use. Section V describes recent empirical trends regarding the yen’s use as an international currency. In light of the view set-forth by several writers, including Asanuma (1988), Dornbusch (1989), Frankel (1989b), and (Black 1990), that a yen zone is emerging in Southeast Asia, 2/ the section also presents data on the yen’s use as a regional currency in Asia. Concluding comments are provided in Section VI.

II. The Theory of International Currency Use

1. Characteristics of an international currency

The uses of a currency in the international monetary system are analogous to, albeit more complex than, those of a national currency serving as a unit of account, means of payment, and store of value for domestic residents. The international use of a currency occurs whenever a national currency performs the functions of medium of exchange, unit of account, or store of value beyond the borders of the nation that issued it. As a means of payment, it is used to settle foreign-trade transactions and to discharge international financial obligations. As a unit of account, an international currency is used in invoicing merchandise trade and in denominating financial instruments. International currencies are also used by official agents in expressing exchange rate relationships. As a store of value, an international currency serves as an investment asset (e.g., in the form of bonds held by nonresidents). For example, official agents hold international currencies and financial assets denominated in such currencies as reserve assets.

An international currency is also used as a vehicle—i.e., as a currency used to denominate and execute foreign trade and international capital transactions that do not involve direct transactions with the issuing country. For example, if Japanese exports to the United Kingdom are denominated and paid for in U.S. dollars, the U.S. dollar is used as a vehicle. A currency is used as a vehicle when the transactions costs (e.g., the costs of information, search, negotiation) using it are less than transactions costs using other currencies. The transactions costs of using a currency are less the lower its exchange rate volatility (and, hence, risk), and the larger the volume of transactions conducted in that currency. As Kubarych (1978, p. 18) has observed with respect to the vehicle use of the U.S. dollar: “Since the dollar is the main currency for international trade and investment, the dollar market for each currency is much more active than between any pair of foreign currencies. By going through the dollar, large amounts can be traded more easily.” 3/ Moreover, once a currency emerges as a vehicle, economies of scale enter into play, decreasing transactions costs further and enhancing the currency’s position as a vehicle (see Swoboda, 1968; Krugman, 1984).

2. The origins of international-currency status

Two sets of factors are necessary for the international use of a nation’s currency. 4/ First, there needs to be confidence in the value of the currency and in the political stability of the issuing country. High and variable inflation rates—relative to those of other countries—generate nominal exchange rate depreciation and uncertainty. 5/ In order to serve as an international unit of account, means of payment, and store of value, a currency should embody sufficient information to make it generally accessible without the need for costly investigation. However, unlike movements in relative prices through which market information is transmitted, inflation serves to reduce the purchasing power of money. Furthermore, inflation can be misinterpreted by economic agents as a relative price signal, causing the transmission of market information to be less accurate than otherwise, creating uncertainty and leading to an inefficient allocation of resources. 6/ In turn, a protracted record of relatively low levels of inflation and of inflation variability depends importantly upon stable and consistent government policies, particularly monetary policy.

Second, a country whose currency is used internationally should possess financial markets that are broad (e.g., contain a large assortment of financial instruments), deep (e.g., existence of well-developed secondary markets), and substantially free of controls (such as trade restrictions and capital controls). For example, a well-developed bankers’ acceptance market contributes to the amount of trade financed in a currency, and thus, to trade invoicing in that currency. 7/ Correspondingly, active short-term (e.g., Treasury bill and commercial paper) markets contribute to the international demand for currencies, reflecting central banks and other investors’ preferences for liquid and safe financial instruments. Strong penetration of foreign financial firms in the domestic market also contributes to international use of the domestic currency in that it stimulates foreign investment in domestic securities.

In general, just as relatively-low levels of inflation and inflation variability contribute to the demand for international currencies, well-developed financial markets facilitate the supply of, as well as the demand for, such currencies. Thus, the large and free financial markets of New York and London contribute to the use of the dollar and the pound sterling, respectively, as international currencies. 8/ On the other hand, the Tokyo financial market was, until recently, rather tightly regulated, inhibiting the use of the yen as an international currency.

3. Theoretical aspects of invoicing practices

a. The choice of an invoicing currency

While the foregoing conditions are important determinants of international currency use, they do not suffice to explain the emergence of a currency as an international currency. In this regard, studies of international invoicing practices have shown the following (see Tavlas, 1991): (i) trade between developed countries in manufactured products is likely to be invoiced in the currency of the exporter; (ii) currency hedging by importers in forward markets is not very prevalent; (iii) invoicing in the exporter’s currency is more recurrent for differentiated manufactured products with long production lags; (iv) trade between developed and less-developed counties tends to be denominated in the currency of the developed country, although the U.S. dollar is also frequently used; and (v) trade in primary products and transactions in financial investments are usually denominated in U.S. dollars and to a lesser extent in sterling.

What explains these observed invoicing patterns? 9/ Whenever an importer or an exporter invoices in a foreign currency, their revenues or costs (in terms of domestic currency) will be affected if the exchange rate changes. Traders can, of course, use the forward market to cover their risk. But as the observed patterns of invoicing behavior have shown, the use of the forward market is not very prevalent. Such markets are typically thinner than spot markets and, therefore, entail larger bid-ask spreads (i.e., higher costs).

Consequently, when making the invoicing decision both the exporter and the importer attempt to minimize the variance of their total profits; this variance is a measure of risk and depends importantly on the covariance between revenue and costs (McKinnon, 1979; Bilson, 1983). Under foreign exchange invoicing, the covariance between an importer’s receipts and unforeseen exchange-rate changes is likely to exceed the covariance between an exporter’s cost (i.e., factor payments) and exchange rate variations. Importers are often in a position to guard against currency fluctuations by passing-through the consequences of unfavorable exchange rate movements (i.e., depreciation) to their customers in the domestic market. This course of action is most practical in small, open economies in which a large domestic importing-competing industry does not exist (i.e., there is an inelastic demand curve for the product), and helps explain why trade between developed and developing countries is usually denominated in the currency of the developed country.

In contrast, exporters are more prone to guard against unexpected exchange rate changes by invoicing in their own currency. Specifically, the covariance between exchange rate movements and their costs is likely to be relatively low, since they cannot easily cut factor payments that have been contractually set. In this connection, the longer the production lag, the higher the exporter’s exchange risk. Consequently, exporters of specialized manufactured products (i.e., goods with long production lags) have a particular incentive to invoice in their home currency.

b. Inflation variability, information costs and invoicing

The preceding discussion can shed light on the relationship between high and variable inflation, and the choice of the invoicing currency. Consider, in this connection, the case in which inflation in the importer’s currency is higher and more unstable than that prevailing in the country of the exporter. High and variable inflation rates increase the costs of ascertaining information and performing efficient calculations about the prices for goods and capital assets, decreasing the information content of prices in the importer’s country. 10/ Therefore, transactors in that country have less scope to decompose price variations into changes in the general level of prices and changes in relative prices; trading is more likely to take place at “false” prices. Since the high degree of noise increases the difficulty of extracting information about relative prices, under foreign exchange invoicing the importer is in a better position to pass-through exchange rate movements on to the domestic economy. The fact that prices convey relatively-little information means that an increase in the price of a particular good is less likely to be perceived as a change in its relative price; the demand for the product will be less elastic with respect to prices. Thus, high and variable inflation in the importer’s country could encourage invoicing in the currency of the foreign (i.e., low and stable inflation) country.

The role of prices in disseminating information helps explain why trade in primary products and capital assets is usually denominated in a common vehicle currency. Primary products and capital assets are typically characterized by low levels of product differentiation and they are traded in competitive markets. In such markets, using as a numeraire a currency with which there is widespread familiarity minimizes costs of information and calculation. Consequently, the choice of invoicing currency in these markets usually narrows to the selection of a single currency (or, at most, several vehicle currencies), since it is more efficient to transmit price change information about homogenous products in a single currency than through many currencies. For example, if five currencies are used to invoice the price of a primary commodity, there are ten bilateral exchange rates and 30 triangular cross-rates to consider. 11/ Therefore, in markets for homogeneous products economies of communication lead to price quotations in a single currency. As Page (1981, p. 62) has noted: “the larger a country’s trade, the more likely are its currency, and probable movements in it, to be already familiar to traders.” Hence, such currencies are more apt to be used as vehicles in denominating the prices of primary commodities.

III. The Determinants of International Currency Use: Implications for the Japanese Yen

What are the implications of the evolution of these factors that promote internationalization for the use of the Japanese yen as an international currency? In order to address this issue, the following discussion assesses: (i) Japan’s recent historical record on inflation; (ii) institutional characteristics of Japanese financial markets; and (iii) relevant patterns of Japan’s foreign trade. As the importance of the determinants of international currency use—i.e., inflation, domestic financial markets, and trade patterns—depends upon Japan’s performance relative to other countries, the discussion considers—to the extent feasible—the position of Japan relative to other major industrial countries.

1. Monetary policy and inflation performance

During the first half of the 1970s, monetary policy in Japan was implemented through the use of both interest-rate and quantitative indicators, with the aim of attaining a variety of objectives including real growth, low unemployment, balance of payments equilibrium, and price-level stability; however, the latter objective was at times given somewhat less emphasis than the others (Shimamoto, 1983; Suzuki, 1987; Batten et al., 1990). With the growth rates of both narrow and broad measures of the money supply peaking at about 30 percent in 1972, and in the wake of the first oil price shock, consumer price inflation rose to double digit levels from 1973 to 1975 (Suzuki, 1987, p. 329).

This experience with double-digit inflation contributed, beginning in 1975, to changes in the implementation and objectives of monetary policy. Monetary policy evolved from a system implemented through credit controls in association with regulation of interest rates, to a system geared more to medium-term monetary control with market-determined interest rates aimed at achieving price-level stability; 12/ flexibility of interest rates was fostered by extensive financial and foreign exchange liberalization (Batten, et al., 1990). As part of this evolution, the intermediate target of monetary policy employed by the Bank of Japan shifted in mid-1978 from lending by financial institutions to the nonbank sector (mainly the corporate sector) to the supply of a broadly-defined monetary aggregate. 13/ In particular, since 1978 the Bank of Japan has announced in the first month of each quarter a projection—as opposed to a target—for the year-on-year growth of broad money measured from the same quarter of the previous year. These changes in both the implementation and the objectives of monetary policy have contributed to sharp decelerations in the growth rates of the monetary aggregates. For example, whereas annual growth of narrow money (Ml) averaged over 12 percent in the 1970s, growth in that aggregate fell to an annual rate of about 5 percent between 1980 and 1989. Likewise, growth of broad money (M2 plus certificates of deposit) averaged over 15 percent in the 1970s, but fell to under 9 percent between 1980 and 1989. 14/

A medium term, anti-inflationary orientation for monetary policy was also adopted by Germany, France, Italy, Switzerland, the United Kingdom, and the United States in the 1970s. 15/ The outcomes of these policies in terms of the inflation objective are reported in Table 1; this table—reproduced from Tavlas (1991)—presents the average annual inflation rate (in terms of consumer prices) for these countries and Japan during 1970-89 and several subperiods.

Table 1.

Inflation and Inflation Variability 1/

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Source: IMF, International Financial Statistics.

Based on consumer price indices. Inflation variability is measured by the standard deviation using quarterly data for the indicated periods.

Over the period as a whole, Japan experienced the third lowest inflation rate (5.7 percent)—well above the rates experienced by Germany (3.9 percent) and Switzerland (4.2 percent), and slightly less than the rate in the United States (6.4 percent); the other countries reported in the table registered much higher inflation rates. However, the message conveyed by Table 1 changes substantially if the separate intervals are considered. During the decade 1970-79 Japan experienced the third highest inflation rate (9.3 percent) among the seven countries; in fact, during the subperiod 1970-74 Japan had the highest inflation rate (11.5 percent). In contrast, during the decade 1980-89 Japan registered the lowest inflation rate (2.5 percent), below those of Germany (2.9 percent) and Switzerland (3.3 percent), and less than half the rate experienced by the United States (5.6 percent).

Table 1 also reports the standard deviations of national inflation rates as a measure of inflation variability. These data tell a similar story. Over the entire period 1970-89, Japan experienced the third highest inflation variability (5.5 percent), only slightly below those of Italy (5.9 percent) and of the United Kingdom (5.8 percent). This outcome is again attributable to Japan’s performance in the 1970s; during that decade Japan had the highest inflation variability (5.9 percent) among the seven countries. In contrast, Japan registered the third lowest inflation variability in the 1980s; at 2.2 percent, it was only slightly above that of Switzerland (1.8 percent) and Germany (2.1 percent).

These data indicate that relative to other major industrial countries, during the 1980s the medium term orientation of Japan’s monetary policy was successful in maintaining a stable internal value of the yen; therefore, Japan’s inflation performance could have established credibility for the nation’s monetary policy, contributing to the international use of the yen. However, to the extent that Germany and Switzerland have achieved relatively-low inflation and inflation variability performances over a longer period, these countries may have achieved greater credibility for their monetary policies than in the case of Japan.

2. Liberalization of financial markets and capital flows

a. Overview

For a number of years leading up to the mid-1970s, the Japanese monetary authorities attempted to discourage the international use of the yen. As Frankel (1984, pp. 33-34) has observed, the Japanese monetary authorities “were concerned that extensive foreign holdings of their currency would reduce their degree of control over the money supply, and would increase the variability of the exchange rate.” 16/ Accordingly, the Japanese financial system was tightly regulated via controls on the quantity and distribution of credit and on interest rates which were generally below market-clearing levels. In particular, the financial system was rigidly segmented and designed to enhance personal savings so that the investment needs of private industry and the rebuilding of public sector infrastructure could be financed at low interest rates. In addition, controls on capital flows insulated the financial market from foreign influences. The guiding principle underlying foreign influences was to “forbid virtually all capital transactions, except by prior approval” (Morgan Guaranty, 1984, p.3).

A number of factors emerged during the 1970s which provided a strong impetus for financial market deregulation. 17/ Following the first oil-price shock, the growth of the Japanese economy sharply decelerated as did investment activity in the corporate sector; consequently, the demand for funds by the corporate sector declined. During the same period, a large government budget deficit materialized as the Japanese economy entered a contractionary phase. Accordingly, the public sector assumed the position of net borrower, and it became necessary to divert personal savings from industrial investment to the financing of the budget deficit. As Eken (1984, p. 506) has noted, the amount of government bonds outstanding rose eight-fold in absolute terms during the fiscal years 1974/75 to 1981/82 (from the equivalent of 7 percent of GNP, to 32 percent of GNP).

This situation contributed to a rapid growth of Japan’s primary and secondary bond markets and led to pressures from the financial community for improvements in the efficiency of financial markets. For example, under institutional arrangements by which long-term government bonds with a maturity of 10 years were underwritten by a syndicate consisting of major financial institutions (required to purchase and hold for specified periods the bonds they had underwritten), a rising share of banks’ portfolios consisted of government bonds. To contain the debt-servicing burden, interest rates on new issues were often kept below market - clearing levels, leading to lower bank profits (Eken, 1984, p. 508; Morgan Guaranty, 1984, p. 4). As a result, banks lost market shares in part because their regulated interest rates could not compete with those of other financial institutions; the banks, therefore, sought freedom to offer new instruments (such as negotiable certificates of deposit) and new businesses (such as the bond-repurchase market).

Against this background, liberalization measures were implemented in the domestic financial market beginning in the late 1970s, creating and developing new markets, and deregulating interest rates. The first significant measure was the authorization of resale of government bonds by syndicated banks, thereby creating a secondary market for rapidly accumulating government bonds. Yields on the new issues of government bonds rose gradually to the level of unregulated yields on the secondary market. In recent years, both the primary and secondary markets for government bonds have expanded rapidly. The greater availability of government bonds facilitated the development of the Gensaki market (repurchase agreement on government bonds) and the market for certificates of deposit, the two main instruments in the open money market with unregulated interest rates. Liberalization initially focussed on large denomination instruments (time deposits, money market certificates and certificates of deposit), and has gradually been applied to smaller-denomination instruments. In what follows, measures taken to liberalize capital flows and domestic markets, that bear directly upon the international use of the yen, are briefly discussed.

b. Liberalization of capital flows

The enactment of the Foreign Exchange and Trade Control Law in 1980, established the principle that capital flows should be free, unless specifically restricted. 18/ Nevertheless, the law contained a set of restrictions pertaining to implementation; these restrictions included a large number of reporting and prior notice provisions, as well as requirements for prior approval of some transactions, on nonresidents’ yen-denominated bond issues in Tokyo, euro-yen bond issues, euro-yen certificates of deposit, euro-yen lending, and interest paid on nonresidents’ yen-denominated deposits.

A new phase began in May 1984 with the release of a report by the Yen-Dollar Committee—a working group of Japanese and U.S. officials—and an accompanying report by the Ministry of Finance titled “Current Status and Future Prospects for the Liberalization of Financial and Capital Markets and the Internationalization of the Yen.” 19/ These two documents took note of the importance of financial liberalization and internationalization to the Japanese economy, proposed changes, and set up a schedule of measures for subsequent years.

Since 1984, a number of measures have, in fact, been taken to liberalize international yen transactions. Among the major measures that have been implemented are the following: (i) in December 1984, eligibility to issue euro-yen bonds by nonresidents was extended to include foreign private corporations which had a credit rating of at least “A” and met certain minimum standards with regard to their financial positions (previously, only international organizations and national governments had been authorized to issue euro-yen bonds); (ii) in April 1985 there was a further relaxation regarding the issuance of euro-yen bonds by nonresidents doing away with the criteria pertaining to financial positions and allowing three Japanese institutions to become approved credit rating agencies; 20/ (iii) also in April 1985, the withholding tax on nonresidents’ interest earnings on euro-yen bonds issued by Japanese residents was abolished; (iv) in June of 1985, foreign banks were extended access to the euro-yen bond market; (v) in November 1987, nonresidents were allowed to issue euro-yen commercial paper (in parallel with the opening of the domestic commercial paper market); and (vi) in May 1989, euro-yen lending to residents was relaxed. These and other liberalizing measures with respect to the euro-yen market are reported in the Appendix.

Despite these measures aimed at liberalizing the use of the yen in international financial markets, several restrictions remain. In this regard, the market for nonresidents domestically-placed yen bonds has a number of drawbacks (Osugi, 1990, pp. 12-13). Specifically, the secondary market for this type of domestic bond is narrow, there is a complex issuing procedure, and privately placed nonresident bond issues are strictly controlled. 21/ In addition, residents are not allowed to hold euro-yen deposits or to purchase euro-yen certificates of deposit.

c. Deregulation of the domestic markets

The progressive liberalization of external transactions has been accompanied by measures to deregulate the domestic financial markets. These measures have aimed to: (i) widen the range of domestic assets with market-denominated interest rates; (ii) relax the segmentation of domestic markets and widen the scope of foreign institutions’ participation in Japan’s financial markets; and (iii) strengthen bank supervision.

For purposes of this study, several specific deregulatory measures are worth mentioning. First, a yen-denominated bankers’ acceptance market was established in June 1985 for trade bills with a minimum denomination of Y 100 million and maturities of one to six months. Second, in June 1985 the Government was allowed to issue short-term bonds for the refinancing of existing debt, similar to Treasury bills in some other countries. Such bonds were publicly auctioned for the first time in February 1986. Third, the commercial paper (CPs) market, established in November 1987, developed rapidly as a source of short-term finance for nonfinancial corporations. The number of enterprises eligible to issue CPs was increased from 190 to 400 in December 1988, and the outstanding balance of CPs increased from ¥ 9 trillion at that time to ¥ 13 trillion at the end of 1989. Further reforms, introduced in 1990, permitted major companies to issue CPs in overseas markets (effective January 1990). Fourth, a number of measures have been implemented to provide foreign financial institutions easier access to the Japanese market; following these latter measures, between 1985 and 1988 the number of foreign banks operating in Japan rose from 233 to 254, and the number of foreign securities firms rose from 139 to 182 (Table 2). 22/ Finally, in 1989 and 1990, a number of measures were taken to open and promote financial futures trading including the establishment of futures markets for the yen-dollar exchange rate, euro-yen and eurodollar interest rates, U.S. Treasury bonds, and stock-index futures.

Table 2.

Internationalization of Japanese Banking and Financial Institutions

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Sources: Bank of Tokyo, Tokyo Financial Review. July 1987; and Japanese Ministry of Finance, Annual Report. various issues.

Implies at least 50 percent ownership.

While the foregoing measures deregulating the domestic financial system have, in general, encouraged an increased international use of the yen, it is important to note the following: (i) the bankers’ acceptance market has remained insignificant and, in fact, has declined in size in recent years. 23/ The complicated operating procedures in this market have restrained the amount of trade financed in yen (Yamasaki, 1989). Participants in the market are required to confirm the details of yen-denominated trade financing provided by the foreign banks issuing the bills. Also, participants are required to collect documents from the issuing banks ensuring that these banks will not raise funds in other markets to refinance the yen-denominated trade credits; (ii) the Treasury bills market is not very active, 24/ and the trading in the government repurchases market is complex (Yamasaki, 1989); 25/ (iii) despite the increased presence of foreign financial firms in Japan, foreign penetration is still relatively limited (Yamasaki, 1989); and (iv) a significant segment of the short-term markets is restricted by the continued administrative structure of interest rates; at the end of 1989, only 54 percent of bank deposits earned market-determined interest rates. 26/

d. The Japan offshore market

In the aftermath of the report of the Yen-Dollar Committee, the Japanese Ministry of Finance established a Subcommittee on the Internationalization of the Tokyo Market to examine the recommendations of the Yen-Dollar Committee. As a means of further promoting the international use of the yen, the Subcommittee recommended the establishment of an offshore banking market in Tokyo, whereby banks could accept deposits from nonresidents without having to meet reserve requirements and other restrictions applicable to Japanese residents in the domestic market. 27/ The rationale for removing restrictions only on transactions involving nonresidents was to increase the offshore centers’ share of international bank intermediation without reducing the effectiveness of domestic financial regulation on residents (Rosenbluth, 1989, p. 59). The aim of creating such an offshore facility was to establish Tokyo “as a center for the world’s transactions in yen and thus aid the expansion of euro-yen transactions and the progress of internationalization of the yen” (Suzuki, 1987, p.127). For example, the offshore market was expected to result in lower costs for domestic financial institutions compared with the cost of establishing branches abroad, thereby allowing “an opportunity for increased profits through the expansion of euro-yen activity” (Suzuki, 1987, p. 127). As Frankel (1984, p.44) observed, the establishment of an offshore market was expected to “help grease the wheels of capital movement,” encouraging the supply of, and demand for, yen-denominated financial instruments.

The Japan offshore market opened in December 1986 and has grown rapidly since its inception. 28/ As reported in Table 3, the market’s volume was almost $400 billion at the end of 1988. As Osugi (1989, p. 26) observes, this volume was “on a par with [those of] the neighboring offshore markets of Hong Kong and Singapore.” While positions in foreign currencies are greater than those in yen, the yen’s share of positions vis-à-vis nonresidents nearly doubled between 1986 and 1989, rising from 21.6 percent to 42.7 percent. The Japan offshore market does contain, however, a number of restrictions, including: eligible counterparties are limited to nonresidents, except for offshore accounts of resident banks; securities transactions are prohibited; local taxes and stamp duties still apply; and individuals are not allowed to participate (Osugi, 1990, p.27).

Table 3.

Development of the Japan Offshore Market

(End-of-year, asset amount in billions of U.S. dollars; figures in brackets: percentage share)

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Source: Osugi (1990); Bank for International Settlements, International Banking and Financial Market Developments. May 1990.

3. Trade patterns

Three of the factors found to influence invoicing behavior were the following: (i) a country’s share of world exports; (ii) the proportion of a nation’s exports to developing countries; and (iii) the share of a country’s exports comprised of specialized manufactured products. Data presented in Tavlas (1991) on each of these factors imply a growing use of the yen as an invoicing currency. Specifically, these data show that during the 1980s (i) Japan’s share of world exports, and the proportion of its exports to developing nations, each rose by about 2 1/2 percentage points, more than in any other large industrial country; and (ii) between 1980 and 1989, the proportion of specialized manufactured products in Japanese exports increased 12 percentage points, to 72 percent. The proportion of such products in total exports for the United States grew by 5 percentage points (to 49 percent); and Germany recorded a 4 percentage points increase (to 43 percent).

In order to discern the implications of these data for the use of the yen in Asia, Tables 4 and 5 report data on Japan’s trade with selected Asian countries. Table 4 separates the direction of Japanese exports and imports according to the following categories: Asian countries, industrial countries, developing countries excluding the Asian countries, and the world excluding the Asian countries. 29/ As the table shows, during the 1980s the direction of Japan’s trade moved progressively toward the Asian countries and the industrial countries. For example, whereas the shares accounted for by the Asian countries in Japan’s total exports and imports were both about 21 percent in 1980, by 1988 those shares had increased to over 27 percent. Likewise, the shares of Japanese exports and imports accounted for by industrial countries each rose by about 15 percentage points between 1980 and 1988. It is also worth noting that the share of Japanese exports accounted for by the United States rose from about 25 percent in 1980 to about 35 percent by the late 1980s. The United States is unique in that more than 80 percent of its imports are denominated in its own currency (see below). Accordingly, the large increase in the U.S. share of Japanese exports should have, in and of itself, worked against the use of the yen in Japan’s export invoicing. Further, some writers (e.g., Marston, 1990; Osugi, 1990, pp. 46-48) have noted that Japanese exporters have, to some extent, sought to price their exports in foreign currencies in order to maintain market shares. Specifically, by invoicing their exports in foreign currencies, Japanese firms have, in the case of yen-appreciation, avoided losses in sales volume while absorbing declines in profits. Finally, an interesting feature shown in Table 4 is the large decline in the shares of both Japan’s exports to, and imports from, developing countries excluding the NICs; in fact, Japan’s exports to, and imports from, those countries declined in nominal terms between 1980 and 1988.

Table 4.

Direction of Japanese Trade

(Percent of total)

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Source: IMF, Direction of Trade Statistics. Yearbook 1989.

Percent change of absolute levels (expressed in U.S. dollars) over 1980 to 1988.

Includes China, Hong Kong, Indonesia, South Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand.

Table 5.

Share of Japanese Exports by Product Category to Asian Countries and the World

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Source: Data Resources Inc.

Includes China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand.

Table 5 presents data on the share of Japan’s exports by product category to the same group of Asian countries included in the previous table. As noted, the most important category in terms of its influence on the use of a nation’s currency in export invoicing is specialized manufactured goods—i.e., machinery and transport equipment. Table 5 shows that between 1980 and 1989 the share of Japan’s total exports to Asian countries comprised of such products rose by an even greater extent than did Japan’s exports of these products to the world as a whole. Thus, whereas the share of specialized manufactured goods in Japan’s exports to the world rose by 11.6 percentage points (from 60 percent to 71.6 percent) between 1980 and 1989, the respective share of such goods in the country’s exports to the Asian NIC’s rose by 15.2 percentage points (from 41.9 percent to 57.1 percent), an even greater gap in terms of percent change from the base. Consequently, these data suggest that the use of the yen for invoicing Japan’s exports to the Asian countries should have increased during the 1980s.

To summarize, several factors that together imply a growing role for the yen as an international currency have been identified. These factors are: (i) Japan’s performance with respect to inflation during the 1980s and the associated gain in the credibility for Japanese monetary policy; (ii) the liberalization of Japan’s financial markets and the lifting of controls on capital flows; and (iii) the increase in Japan’s share of world exports, and the growing shares of such exports that are both comprised of specialized manufactured products and directed to developing (i.e., Asian) countries. On the other hand, Japan’s late entry into the low-inflation club and its delayed implementation of financial deregulation measures relative to some other countries may have served to impede the use of the yen internationally. Several restrictions remain in Japanese financial markets, including some controls on short-term interest rates; additionally, markets in Treasury bills, and bankers acceptances are thin, a commercial paper market was only recently developed, and some euro-yen transactions by Japanese residents are regulated. Also, although some trends in Japanese trade suggest a growing role for the yen in international trade transactions, there are several factors not working in that direction: (i) a rising share of exports to industrial countries (particularly the United States) has occurred, and these countries tend to denominate imports in their own currency; (ii) there is evidence that Japanese exporters have sought to denominate in foreign currencies in order to maintain market shares (while absorbing declines in profits); (iii) the absolute level of Japan’s exports to non-Asian developing countries has declined; (iv) the thin bankers’ acceptances market has made it more difficult than otherwise for Japanese firms to obtain trade financing in yen. With regard to the yen’s regional use, the rising proportion of Japan’s exports directed toward Asian countries, and the growing share of such exports comprised of specialized manufactured products, indicate an increased scope for the use of the yen as a regional Asian currency.

IV. Japan’s Capital Outflows: Implications for the Yen’s International Use

1. Overview

This section discusses the relationship between a nation’s capital flows and international currency use. In this connection, several writers (e.g., Black, 1990; Frankel, 1989b) have suggested that the implications in recent years of the pattern of Japan’s capital flows (borrowing short, on net, and lending long, on net) for the international use of the yen are comparable to the earlier periods during which sterling and the U.S. dollar, respectively, emerged as international currencies. Thus, Black (1990, p. 175) states that Japan’s “[external] position is analogous in some ways to that of American banks in the postwar period 1945 to 1980 and to British banks in the 19th and early 20th centuries as bankers to the world, borrowing short and lending long.” 30/ Likewise, Frankel (1989b, p. 2) argues that the emergence of the United States as a net-debtor country will diminish the international role of the dollar, and “with Japan now the world’s largest creditor, the dollar’s loss should be the yen’s gain.” Accordingly, the section also examines the extent to which Japan’s position as an exporter of long-term capital (on net) has served to facilitate the international use of the yen.

2. International financial intermediation and the roles of the capital and current accounts

a. The role of the capital account: the nation as world banker

A country’s financial institutions engage in international liquidity transformation when they supply loans and investment funds to foreign enterprises that would have to pay more in their home countries to borrow long-term, and when they supply liquidity to foreign asset holders who would receive less (in terms of interest payments and/or capital certainty) for holding their short-term deposits at home. Diversification of their portfolios provides the financial intermediaries with reduced risk and cost relative to the risk that would be borne by an individual investor whose holdings are often too small to allow diversification; also, economies of expertise enable them to evaluate risk more efficiently, than individuals can. 31/

A nation’s ability to serve as an international financial intermediary (i.e., world banker) is directly related to the necessary conditions for international currency use noted above. In particular, a nation’s capacity to attract short-term capital denominated in its own currency depends importantly upon the certainty of the currency’s value (and, therefore, on the nation’s inflation performance), and the availability of a wide range of safe, liquid financial instruments denominated in that currency. For example, if foreigners are acquiring short-term claims (i.e., supply short-term capital) on net in the currency of a particular country, it implies that: (i) the country possesses a large supply of short-term, relatively high-yielding financial instruments denominated in its own currency, (ii) the access to such instruments is relatively free from controls; and (iii) foreigners attach a relatively-high degree of certainty to that nation’s currency (and, therefore, the nation has a relatively-low and stable inflation rate). Foreigners may demand short-term claims denominated in such a currency in part for liquidity and/or investment, or to pay for imports denominated in that currency. At the same time, that nation’s ability to attract short-term capital enhances its capacity to supply longer-term loans to the rest of the world; furthermore, the supply of longer-term capital to the rest of the world denominated in the nation’s currency also facilitates the international use of its currency since it encourages foreigners to hold their short-term claims in that currency. As Williams (1967, p. 268) observed with respect to the earlier sterling system, foreigners held short-term claims in sterling in part “to meet sterling obligations in London.” 32/

Consequently, the nation can function as a world banker; a manifestation of this activity on the capital account is that the nation imports short-term capital (on net) and exports longer-term capital (on net) denominated in its own currency, though its overall capital account position can be in balance. In conjunction with its role as a world banker, the growth of a nation’s liquid liabilities can exceed that of its official reserves. As Kindleberger and Lindert (1978, p. 265) noted with respect to the financial intermediary role of the United States in the 1950s, the nation’s liquid liabilities were growing faster than its reserves, but it also had “such extensive longer-term, less liquid, assets abroad that the nation was a heavy net creditor to the rest of the world overall…[Thus] the United States was acting as a financial intermediary, lending long and borrowing short.” A nation’s ability to serve the world banker role depends upon the necessary conditions for international use. Given those conditions, a nation could be borrowing short and lending long in its own currency, thereby enhancing the international use of that currency.

b. The current account and international currency use

A country with a current account surplus accumulates net claims on the rest of the world; the rest of the world accumulates net claims on a country with a current account deficit. An interesting issue is whether a current account imbalance (and, therefore, imbalance of the capital account) contributes to the international use of a country’s currency, and, in particular, its use to denominate foreign claims (assets and/or liabilities held by nonresidents).

In fact, there is little connection between a nation’s current account position and international currency use. Thus, a nation can experience persistently-large current account surpluses and not have its currency used internationally because its exports may not be denominated to a substantial extent in its own currency. In this case, foreigners do not need to hold short-term claims denominated in the exporter’s currency to pay for those exports. Hence, the determinants of invoicing behavior discussed above are the main factors influencing the trade side of international currency use. Correspondingly, a nation with a persistently-large current account surplus and whose exports are largely denominated in its own currency also need not have its currency used internationally. For example, if such a country also has tightly regulated financial markets and capital flows, there may be little opportunity for foreigners to hold claims denominated in that nation’s currency. Further, regardless of the currency denomination of a nation’s exports and the characteristics of its financial markets, foreigners would be discouraged from holding claims denominated in its currency if they expected the nation to experience high and variable inflation.

Thus, the factors influencing the denomination of international claims are those discussed previously: the extent, nature, and pattern of trade (and hence the choice of invoicing units), the stability of the value of currencies and the depth, breadth, efficiency and openness of markets in financial instruments denominated in particular currencies. In short the willingness of foreigners to hold assets or liabilities denominated in a country’s currency (a gross capital account phenomenon) has little to do with whether the net capital/current account is in balance but depends on the risk/return (including transaction costs) characteristics of financial instruments denominated in the currency. However, such factors as the current account position and the net-debtor position of a country do enter into play to the extent that they affect confidence in a currency, increasing solvency risks and jeopardizing the functioning of a financial market as an international banking center.

These factors help explain, for example, why the Saudi Arabian riyal has not emerged as an international currency, despite the fact that during the 1970s Saudi Arabia recorded huge current account surpluses. Specifically, Saudi Arabia’s exports are predominantly invoiced in U.S. dollars, and Saudi Arabian financial markets are not broad, deep, or substantially free from controls. In contrast, during the 1980s the Australian dollar emerged as an international currency in that it is one of the most actively traded currencies in foreign exchange markets. Yet during this period Australia has recorded annual current account deficits equivalent to about 5 percent of GDP. Underpinning the international use of the Australian dollar has been the complete deregulation in recent years of the Australian financial system, which until 1980 had been tightly controlled. 33/

3. Overview of Japan’s capital account

Reflecting both its current account surplus—the counterpart to the nation’s excess of saving over domestic investment—and its emergence as an international financial intermediary, Japan’s role in the global allocation of capital flows has increased markedly in recent years. In this connection, Table 6 presents Japanese balance of payments data over the 1980s. Several features of these data are particularly noteworthy with regard to Japan’s role in allocating capital flows. First, during the period 1983 through 1989, Japan accumulated a current account surplus of about $415 billion, making that nation the largest net international supplier of capital. Second, net long-term capital outflows during the 1983-89 period totaled about $620 billion, or $205 billion more than the accumulated current account surplus. The balance has been financed mostly by short-term capital inflows. As noted above, the capital flows of a country are conducive to the international use of its currency if a substantial proportion of its financial transactions are denominated in its own currency. Therefore, in what follows, the key issue examined is the extent to which Japan’s external financial transactions have been denominated in yen.

Table 6.

Summary Balance of Payments of Japan, 1980-89

(In billions of U.S. dollars)

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Source: IMF, International Financial Statistics.

Includes gensaki flows.

Numbers in parentheses are percent of GNP.

4. Japan as an international financial intermediary

Japan’s role as an international financial intermediary is highlighted in Table 7 which provides data on that nation’s external balance sheet during the 1980s. As the table shows, by the end of 1989 Japanese residents had accumulated net external assets of more than $290 billion, up from an average of about $30 billion in the first half of the decade. 34/ Reflecting its intermediary function, the predominance (almost 60 percent) of Japan’s foreign claims were long-term while over 60 percent of the nation’s liabilities were on the balance sheets of its banks and were short-term. Also note—in line with the Kindleberger-Lindert (1978, p. 265) view that the “short-term liabilities [of an international banking center] come to be a multiple of official reserves”—the ratio of Japan’s short-term liabilities to official reserves rose from an average of about five in the first half of the 1980s, to about 12 by the end of the decade.

Table 7.

Japan’s External Balance Sheet

(In billions of U.S. dollars, end-of-year data)

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Source: Bank of Japan, Balance of Payments Monthly, various issues.

Japan, however, departs from the traditional model assigned to international financial intermediaries in an important respect. In contrast to the earlier cases of the United Kingdom and the United States, which borrowed short and lent long primarily in their own currencies, commercial banks in Japan have been involved chiefly in maturity transformation of external funds, borrowing short-term funds overseas in foreign currencies (mostly U.S. dollars) and investing funds in long-term instruments overseas denominated in foreign currencies. Specifically, banks as well as some nonfinancial corporations, have capitalized on their good credit-standings in the international capital market to profit from the yield curve structure, borrowing short-term funds to acquire long-term bonds overseas. As reported in Table 8, external lending by Japanese banks increased during the 1980s, but the share of yen-denominated lending—though rising—remained less than one-third of the total. 35/

Table 8.

External Lending by Japanese Banks 1/

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Source: Annual Report of International Finance Bureau. Japanese Ministry of Finance 1989.

Oustanding balance at end of period.

Does not inclucde euro-yen loans.

Since Japanese banks lend predominantly in foreign currencies (mostly U.S. dollars) to take advantage of higher yields abroad, why do the banks also borrow primarily in foreign currencies? One factor accounting for the banks’ foreign currency borrowing is the absence of a well-developed bankers’ acceptance market and the fact that both exports and imports are predominantly non-yen denominated; therefore, as Thorn (1987, p. 87) points out, banks often borrow short-term to make “impact loans” (foreign currency loans to domestic firms) to finance trade. A second factor that appears to have contributed to foreign-currency borrowing by Japanese banks is the fact that such borrowing possesses several advantages over yen-denominated borrowing in Japan. The reserve requirement on all foreign-currency liabilities to nonresidents, regardless of duration or size, is close to the minimum. 36/ Unlike rates paid on other types of deposits, which are regulated, interest rates on foreign currency deposits are set freely by the banks. The maturity of these deposits is left to negotiation between the bank and the depositor, and there are no upper limits to the quantities of such deposits. For large deposits (over $100,000) the interest rates are determined through individual negotiation on a bilateral basis and take into consideration euromarket rates in order to ensure competitiveness with rates in that market (Suzuki, 1987, p. 81).

A third factor accounting for Japanese banks’ foreign currency borrowing is the existence of prudential regulations that limit banks’ net foreign exchange exposure. Specifically, banks’ combined (spot plus forward) net foreign exchange exposure cannot exceed $1 million (positive or negative) at the close of each business day. Consequently, if banks lend in foreign currencies, prudential regulations prompt the banks to also borrow in foreign currencies.

5. Destination and composition of long-term capital outflows

Tables 9 and 10 provide data on capital outflows. With regard to the composition of such outflows, several noteworthy developments can be observed. For one, long-term capital outflows have been concentrated in securities. In turn, as Mattione and Klath (1989, p. 3) have documented, over the five years through 1989 about 85 percent of securities purchases have been in debt instruments with Japanese banks serving as the main investors. Also, direct investment was the second-largest component, at about 23 percent, of long-term net capital outflows in the late 1980s; the share of direct investment has exhibited marked variability, falling from 22 percent in 1980 to 5 percent in 1985, before recovering in the second half of the 1980s.

Table 9.

Japanese Long-Terra Net Capital Outflows by Type and by Destination

(In percent)

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Source: Japanese Ministry of Finance.

Annualized data for the first six months of the year.

Table 10.

Geographic Distributions of Net Long-Term Capital Flows, 1984-88

(In billions of U.S. dollars, minus sign indicates net ouflow of capital from Japan) 1/

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Source: Bank of Japan, Balance of Payments Monthly.

Excluding gensaki transactions. State trading econmies comprise Albania, Bulgaria, Czechoslovakia, the German Democratic Republic, Kampuchea, Laos, Mongolia, Democratic People’s Republic of Korea, People’s Republic of China, Poland. Romania, the U.S.S.R., and Viet Nam.

Data not classified by territories (net receipts accrued from intermediary trade, transactions, nonmonetary gold transactions, etc.).

Turning to the destination of net long-term capital outflows, Tables 9 and 10 also show that in recent years such flows have increasingly been directed toward OECD countries. Thus, in 1980, about half of Japan’s net long-term capital outflows were to OECD countries and about half to non-OECD countries. However, by the late 1980s about 84 percent of such outflows were directed to OECD countries, and about 5 percent to developing countries; in the late 1980s, approximately one-half of net long-term capital outflows was to the United States.

A regional decomposition of Japan’s capital outflows that breaks out the Asian region separately is available with respect to direct investment data and is reported in Table 11. The proportion of Japanese direct investment going to Asian countries fell by half between 1983 and 1989, from about 28 percent to 14 percent. However, this decline reflects several special factors. First, direct investments in Asian countries were abnormally high during the late 1970s and early 1980s because of Japan’s desire to develop supplies of natural resources. 37/ Second, during the 1980s there was a sharp increase in direct investment in industrial countries concurrent with rising trade protection in those countries, the appreciation of the yen (which made dollar-priced imports cheaper,) and the growing presence of Japanese financial institutions abroad. Despite the decline in the share of Japan’s direct investment accounted for by Asian countries, the absolute amount of Japan’s direct foreign investment in those countries tripled (from $1.8 billion to $5.7 billion) between 1983 and 1989, and remained a substantial proportion of their total investment inflows.

Table 11.

Japanese Direct Investment by Region 1/

(In percent)

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Sources: Ministry of Finance, Zaisei Kinyu Tokei Geppo: data supplied by Japanese authorities and staff estimates.

Fiscal years (i.e., April through March).

First half of fiscal year 1989/90.

Excluding Luxembourg.

Includes tax havens: Bahamas, Bermuda, The Cayman Islands, The Netherland Antilles, Luxembourg, and Panama.

6. Japan’s international financial intermediation: implications for the international use of the yen

The discussion above indicates that Japan’s role as an international financial intermediary is characterized by the following attributes: (i) Japanese long-term capital outflows have been concentrated in securities; and (ii) the predominance of capital outflows has been denominated in terms of the U.S. dollar, because of the relatively high-yields available on U.S. securities. As Thorn (1987, pp. 77-79) has observed, Japan’s long-term capital outflows have “largely financed the financial disequilibrium of developed countries.” On the other hand, direct investment to developing countries comprises a small share of net capital outflows, and most of that has been directed toward Asian developing countries. 38/ Thus, the processes underlying the emergence of sterling and the dollar as international currencies, whereby developing (and reconstructing) countries accumulated sterling- and dollar-denominated balances (for liquidity and/or investment, to pay for imports invoiced in those currencies, and to service loans for capital development denominated in those currencies), appear to be less significant in the case of the yen (except with respect to Asian developing countries) than they were earlier for sterling and the U.S. dollar. 39/

With regard to the emergence of sterling and the dollar as international currencies, the well-developed financial markets of the United Kingdom and the United States were conducive to international financial intermediation in terms of sterling and the dollar, respectively. In contrast, Japan’s intermediation has not been denominated predominantly in terms of the yen. Consequently, although Japan has been channeling funds to the rest of the world, that process has not necessarily been conducive to the yen’s international use. Since foreigners have not primarily been accumulating yen-denominated loans, they have had less incentive to accumulate yen-denominated claims to pay back such loans. Further, the fact that the Japanese financial market has been (until recently) tightly regulated, and remains narrow and thin in some areas, has also discouraged the holding of short-term, yen-denominated claims by foreigners.

V. Evidence on the International Use of the Yen

1. Overview

The preceding discussion suggests that, in general, the determinants (i.e. inflation performance, development of financial markets, trade patterns) of international currency use imply some scope for a growing role for the yen in international financial transactions (though not in trade transactions). However, the direction and composition of Japan’s long-term capital outflows indicate that the process through which currencies become international have not been as conducive to the yen’s international use as is indicated by the magnitude of those outflows. In order to determine how these various factors have combined to influence the internationalization and regionalization of the yen, the following discussion presents data pertaining to the yen as an international unit of account, medium of exchange, and store of value.

2. Currency invoicing patterns

The currency invoicing patterns of Japan’s exports and imports from 1975 through 1989 are provided in Table 12. The data show that the proportion of Japan’s exports denominated in yen rose from 17.5 percent in 1975 to 40 percent in 1983; the yen’s share declined to about 35 percent in the second half of the 1980s. (The share of Japanese exports denominated in U.S. dollars remained at over 50 percent in the second half of the 1980s.) With regard to invoicing of imports, the yen’s share rose steadily, from less than one percent in 1975, to about 14 percent in 1989; the dollar’s share of import invoicing fell somewhat, from 83 percent in 1983 to 77 percent in 1989.

Table 12.

Currency Denomination of Japanese Foreign Trade

(In percent of total)

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Sources: Annual Report. International Finance Bureau, Japanese Ministry of Finance, various issues; and data provided by the Japanese Ministry of Finance.

How do Japan’s currency invoicing patterns compare with those of other large industrial countries? Table 13 provides data on trade invoicing in 1980 and 1988 for six countries: Japan, France, Germany, Italy, the United Kingdom, and the United States. 40/ These data show that the proportion of Japan’s exports denominated in its national currency has remained far below the comparable figures of 96 percent for the United States and 40-80 percent for the major European countries. In terms of the national currency component of import invoicing, all countries except the United States experienced substantial increases in the 1980s, with Japan recording the largest percentage gain—a sixfold increase (from 2.4 percent to 14.1 percent); but Japan’s proportion at the end of the 1980s was well below those of the United States (85 percent) and the major European countries (27 percent to 52 percent).

Table 13.

Currency Denomination of Trade Invoicing in Selected Industrial Countries

(In percent)

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Sources: Page (1981); Black (1990); Alterman (1989); Ministries of Finance of France, Germany, Italy, and Japan; and U.S. Bureau of Labor Statistics.

1988 data except for German exports, and Italian exports and imports, which are 1987 data.

Several previously-cited factors account for the relatively-low shares of Japanese exports and imports denominated in yen. First, a large and growing share of Japanese exports are supplied to the United States, and that country’s imports are predominately invoiced in terms of the dollar. Second, Japanese imports are mainly primary products which have been traditionally invoiced in dollars and sterling. 41/ Third, the high transactions costs in the bankers’ acceptance market has restrained the amount of trade financed in yen. Finally, Japanese exporters have apparently sought to invoice in yen to maintain market shares.

A regional breakdown of Japan’s trade invoicing from 1983 through 1989 is presented in Table 14. These data show that yen-invoicing of exports to North America were little changed (at about 15 percent); and declined with respect to Western Europe (from 51 percent to 42 percent) and Southeast Asia (from 48 percent to 44 percent). The data on import invoicing show that yen-invoicing from North America and Western Europe doubled between 1983 and 1989 (to 10 percent and 29 percent, respectively), and that yen-invoicing of imports from Southeast Asia rose to 20 percent, from 2 percent.

Table 14.

Currency Denomination of Japanese Foreign Trade by Region

(In percent of Total)

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Source: Japanese Ministry of Finance.

Excluding South Africa.

3. The yen as a medium-of-exchange vehicle

Developments regarding the volume of currencies traded on foreign exchange markets are suggestive of the relative importance of currencies as unit-of-account and medium-of-exchange vehicles. 42/ Data on the currency turnover in the interbank markets are available from surveys conducted by central banks in New York, London, and Tokyo in March 1986, April 1989, and at earlier dates in New York. These data have been reported in Tavlas (1991). The data show a marked increase in the share of the Japanese yen in the New York market; specifically, the yen’s share in New York trading rose from about 5 percent in 1980 to slightly more than 12.5 percent in 1989. In the London market, the yen’s share rose slightly, from 7 percent to 7.5 percent, while there was a slight decline in the yen’s share in the Tokyo market (to about 36 percent). By comparison, the deutsche mark’s share has been fairly steady in New York and Tokyo, while declining modestly in London. The data also indicate that the interbank markets continued to be dominated by transactions involving the U.S. dollar.

Another measure of a currency’s role as an international medium of exchange is its use in foreign exchange market intervention by central banks. In this connection, the available data—reported in Tavlas (1991)—indicate that there is relatively little use of the yen. For example, intervention within the European Monetary System is primarily in deutsche mark and U.S. dollars. Intervention by the U.S. monetary authorities during the 1980s has been mostly in deutsche mark and yen; the yen’s share of total U.S. intervention rose from about 12 percent in the early 1980s to about 40 percent in the late 1980s, although part of this increase could represent the coordinated efforts undertaken by central banks to support the Japanese currency.

4. The yen as an investment and borrowing currency 43/

Foreign yen claims can be classified into three broad categories: (i) claims held in Japan by nonresidents. These claims are predominantly on Japanese banks and the public sector; 44/ (ii) claims held outside Japan by nonresidents in the form of euro-yen (short-term deposits); and (iii) claims held outside Japan by nonresidents in the form of euro-yen (long-term) bonds.

Data for each of these categories (denominated in U.S. dollars) over the period 1982 through 1989 are reported in Table 15. This table, which for purposes of comparison also includes foreign non-yen claims in Japan, shows the following: (i) borrowing in Japan from foreigners is done mostly by the banking sector. In fact, the public sector’s share of such borrowing has declined in recent years. The share of yen-denominated borrowing by the banking sector rose from 21 percent in the first part of the 1980s, to 33 percent in 1989; (ii) nevertheless, within the banking sector (as noted in the previous section), the predominance of borrowing from foreigners is in non-yen denominated instruments (67 percent in 1989); 45/ (iii) euro-yen claims by foreigners are significantly less than claims (both yen-denominated and non-yen) by foreigners in Japan; and (iv) euro-yen bonds grew by a multiple of more than 15 (from $5.6 billion to $87.7 billion) during the 1980s whereas euro-yen deposits grew by a multiple of less than five.

Table 15.

Foreign Claims in Japan and External Yen Claims

(In billions of U.S. dollars: end-of-year data)

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Sources: International Banking and Financial Developments. Bank for International Settlements, various issues, and the Balance of Payments Monthly. Bank of Japan.

Average for 1983 to 1985.

External liabilities of banks resident in Japan to all sectors as reported to BIS.

Government bonds held by nonresidents.

External liabilities of banks in the euro markets to all sectors as reported to BIS.

A comparison of the euro-yen bond market with the market for nonresidents’ domestically placed yen bonds is provided in Table 16; the table reports data on new issues (i.e., flow data) in the respective markets. Issues of yen bonds placed in Japan declined sharply in 1986 and subsequently remained stagnant; in contrast, euro-yen bond issues rose sharply. Underlying this divergence between the performances of the two markets have been, as noted above, the various rigidities in the domestic bond market for nonresidents, including its underdeveloped secondary market, and the complexity of the issuing procedures. Thus, Tables 15 and 16 show that foreign lending in Japan, which is primarily directed to the banking system and is non-yen denominated, exceeds euro-yen lending by foreigners. On the other hand, yen-denominated bond issues by nonresidents (i.e., foreign borrowing) outside of Japan far exceed nonresidents’ yen-denominated issues in Japan.

Table 16.

Yen-denominated Bond Issues

(In billions of yen)

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Sources: Zaikaikansoku. Nomura Research Institute; Annual Report. International Finance Bureau, Ministry of Finance.

In order to assess the performance of the yen vis-a-vis other currencies in international markets, Table 17 presents data on the use of the yen and other currencies as a store of value and unit of account over the period 1981 through 1989. The data in the table classify the uses of currencies into three types of instruments: (i) external bank loans, which include foreign and international bank loans; (ii) external bond issues, which include foreign and international issues and special placements, and (iii) eurocurrency deposits.

Table 17.

Relative Shares Based on External Capital Market Data

(In percent)

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Source: Financial Market Trends. OECD, No. 30; No. 46, International Banking and Financial Market Developments. BIS, various issues.

The average of 1981-84 data are used since the 1980 data are not consistent with the 1981-84 data.

Data for eurocurrency deposits are through September 1989.

Foreign and international bank loans, excluding loan renegotiations.

Includes international issues, foreign issues, and special placements.

Included in other category prior to 1983.

Includes foreign currency position of banks in the United States for which no currency breakdown is available.