Japan economists call for 'Obama bonds' By Kosuke Takahashi

Japan economists call for 'Obama bonds'
By Kosuke Takahashi

TOKYO - Japanese economists, increasingly concerned that the United States might seek to pay its enormous and growing debt obligations in a weakened US dollar, are looking to the possibility of US Treasuries being issued in yen.

The US government needs to borrow at least US$1 trillion in the coming year, excluding the US Treasury's $700 billion plan to bail out the financial and other industries, said Kazuo Mizuno, chief economist in Tokyo at Mitsubishi UFJ Securities Co, a unit of Japan's largest publicly traded lender by assets. That amount is likely to grow as the US government continues to rescue failed parts of the economy and has to raise more debt - that is, issue government bonds, or Treasuries - to fund such rescues.

Since 2004, when the amount of the government bond issuance reached an annual average of $400 billion, 94% of new buyers of US government bonds have been foreigners, Mizuno told Asia Times Online.

One measure of the increased concern at the ability of the United States to finance its enormous deficits in the future is the rising cost of credit default swaps bought as protection of Treasury debt. These traded near a record high on Tuesday, with benchmark 10-year contracts on Treasuries increased to 42 basis points, or 0.42 percentage points, from around 20 in early September. The contracts have also risen from below two basis points at the start of the credit crisis in July 2007.

While it remains unlikely that the US government will default on its debt, a weaker dollar would ease the burden of payment on existing debt.

In the past few months, the US dollar has strengthened against other major currencies, with the notable exception of the yen, even as the country has been at the epicenter of the deepening financial crisis. That dollar strength is not expected to last.

"There is no wonder the dollar will weaken," said Eisuke Sakakibara, Japan's former top currency official and now a professor at Waseda University. "The dollar now looks strong for a technical reason. The money the US financial firms had invested in the world is being repatriated into the homeland, causing dollar-buying. But once this conversion into the dollars is done, the currency will head south," Sakakibara said at a forum in Tokyo on Sunday.

Faced with the unprecedented growth of the US budget deficit and the prospect of an increasingly weaker dollar compared with the yen reducing the value of Treasury debt held by Japan, economists in Tokyo are calling for the administration of president-elect Barack Obama to issue US Treasuries denominated in yen and other currencies. The issuance of foreign currency-denominated US Treasures would reduce the perceived risk of holding the debt.

The idea of issuing foreign currency-denominated US Treasures is not new. The Jimmy Carter administration, buffeted by the two oil crises of the 1970s, sold "Carter bonds", denominated in German marks and Swiss francs, in 1978 to attract foreign investors into Treasuries.

"The US will be forced to issue foreign currency-denominated US Treasures in its hour of need," said Mizuno. "The US cannot finance its deficit by itself. The US financial system cannot survive without foreign investors. We will see 'Obama Bonds' in the future."

With the US owing increasing amounts to foreign nations, the confidence in US Treasuries continues to be shaken, said Masaaki Kanno, chief economist at JPMorgan Securities Japan Co in Tokyo, said. "This will push up long-term yields, and the dollar will be sold," said Kanno, speaking at the forum in Tokyo on Sunday.

So far, the Japanese yen has been the biggest winner out of the current financial turmoil as investors increasingly unwind the so-called yen carry trade, in which yen borrowed at low interest is changed into other currencies and invested for higher yields than the interest charged on the yen loan.

The yen has advanced 15% versus the dollar this year, 33% against the euro and 53% against the pound sterling. The yen may rise to 85 per dollar this year, predicted Masaki Fukui, senior market economist in Tokyo at Mizuho Corporate Bank Ltd, a unit of Japan's second-largest financial group by market value. The Japanese currency at present is trading at about 96.28 to the US dollar.

"Japan’s financial authorities may intervene in the foreign exchange markets only when the yen breaks 90 per dollar," Sakakibara said.

As the yen strengthens, the effective value of debt held in dollars will decline, a fate that yen-denominated Treasuries would escape.

"Yen-denominated US Treasuries would reduce currency risks for Japanese and Chinese buyers of US Treasuries," said Fukui. "If concerns over US Treasuries continue to grow, no one will want to buy them. Yen-denominated US Treasuries would make it easy for foreign investors to buy them."

Looking ahead to 2009, foreign buyers such as Japan, China and other emerging market central banks are likely to reduce their holdings of US Treasuries rather than increase them, as their own countries face massive funding needs to buoy their economies at home and as America will continue to face financial instability and deteriorating economic fundamentals.

Japan holds the world's second-largest foreign reserves, totaling about $1 trillion, following China, which has about $2 trillion in forex reserves, including some $600 billion worth of US Treasuries. Japan plans to provide up to $100 billion to the International Monetary Fund, which would reduce the nation’s holding of short-term US Treasury bills.

China on November 9 announced its sweeping economic stimulus package valued at about 4 trillion yuan ($586 billion), to be spent over the next two years. Market players are speculating China, to secure financial resources, would reduce its holding of US Treasury securities rather than increase them.

Kosuke Takahashi is a freelance correspondent based in Tokyo. He can be contacted at letters@kosuke.net.

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