Japanese Yen Will the yen appreciate or depreciate in the near future??

Exchange Rate (Yen - US Dollar)

0

20

40

60

80

100

120

140

160

Inte

rban

k R

ate

s

Source: Bank of Japan

Amid current economic problems, Japan faces four major obstacles to recovery:

1) Unemployment

2) Growing Japanese government budget deficits

3) Continuing deflation

4) Crisis in the Japanese banking sector

How the Japanese government and international markets respond to these four issues will largely determine the strength of the Yen going

forward

Unemployment Problem

The Past Five Months: November 2001: 5.25% December 2001: 5.35%January 2002: 5.4%February 2002: 5.5%March 2002: 5.6%168,000 total workers laid

off since November

The government has pumped billions of yen into public service projects and trillions into corporate bailouts in an attempt to avoid an accelerated increase in unemployment.

0%

1%

2%

3%

4%

5%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Japanese Unemployment

Source: Japan Information Network

The Japanese government has pursued a policy of bailing out all companies employing more than 10,000 workers

As a result of continuing bailouts and spending initiatives, public debt is growing in real terms and as a percentage of GDP

Total Government Debt

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Jan-91

Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Yen

(10

0 T

rill

ion

)

0%

20%

40%

60%

80%

100%

120%

140%Debt as a % of GDP

Total Gross Government Debt

Source: Bank of Japan, OECD

Increasing fiscal debt levels have not resulted in a commensurate increase in productivity

Japan’s Corporations

Companies are forced to buy government securities in exchange for the bailouts

Japanese companies also have close links to each other and to banks—“Keiretsu culture”

This spreads the liabilities throughout Japan’s economy

Bank of Japan Helps Fund the Bailout

0

5

10

15

20

25

30

35

1993 1995 1997 1999 2001

BOJ Purchases of JGB as a Percentage

Bank of Japan made a bold move by increasing its purchase of government bonds from 600 billion to 900 billion per month.

The increasing portion of government debt held by the Bank of Japan is an indicator of the weakness of the commercial banking sector

Despite efforts by the Bank of Japan to expand the money supply, deflation continues to plague the economy

Prices and Money Stock

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Ye

n (

Hu

nd

red

Bil

lio

n)

92

93

94

95

96

97

98

99

100

101

102

Pri

ce

In

de

x

Source: Japan Information Network *Money stock is broadly defined liquidity

With prices falling consumers and corporations have little incentive to spend, putting further downward pressure on the currency

A Vicious Cycle

Outstanding Government Securities

0

50

100

150

200

250

300

350

400

450

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Yen

(T

rill

ion

)

Bank of Japan, in an effort to reverse deflation, will pump more money into the economy.

The amount of MIC (money in circulation) has already increased from 1.3 to 1.6 of GDP in 4 years with little influence……

Because of huge payable responsibilities on mature bonds Japanese Government is forced to sell even more bonds…..

Source: Japan Information Network *Money stock is broadly defined liquidity

Source: Bank of Japan

Money Supply, 1997 - 2001

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

1997 1998 1999 2000 2001

Ye

n (

10

0 B

illi

on

)

98

98.5

99

99.5

100

100.5

101

101.5

Pri

ce

In

de

x

M1

M2+CDPrices

Current State of Japan’s Banks

Current Total NPLs

•24.1 trillion yen

•17% of GDP; 20% default rate

•New record of nearly 20,000 bankruptcies.

Collateral Problems

•Current Prices of Commercial Land is 23% of 1991 figures

Source: Japan Information Network

0%

1%

2%

3%

4%

5%

6%

Jul-

91

No

v-9

1

De

c-9

1

Ap

r-9

2

Jul-

92

Fe

b-9

3

Se

p-9

3

Ap

r-9

5

Se

p-9

5

Fe

b-0

1

Ma

r-0

1

Se

p-0

1

Official Discount Rate - BOJ

The volume of non-performing loans have revealed severe weaknesses in the Japanese banking sector….

Going Forward—A Risky Situation

• The BOJ requires all banks to hold 8% of capitalization in liquid funds to be an international lender.

• By this winter, three of the four largest banks had already dropped below this threshold:

UFJ Sumitomo Bank

Mitsui Mizuho

• Dropping below the 8% threshold increases costs in addition to suspending international financing activities

• Under new Japanese accounting regulations companies losing more than 50% paper value in a fiscal year must book the new value levels as book value.

How close did Japan come to the Magic Numbers?February 6 - Nikkei average (9,420.85)

• 75% of all trades on the Tokyo Stock Exchange were “shorts”

March 31 - Nikkei average (11,029.94)

Consensus was that the banking sector would be forced to recognize these losses if the Nikkei fell below 11,000

Outlook for the US Dollar?

Oil shocks?War in the Middle East?

Increased popularity of the Euro?Bush Administration’s views?

Many Uncertainties…

Short-term view is that dollar will likely rise against most currencies

Conclusion: Will the yen depreciate and, if so,

when?

Yen’s depreciation will accelerate this June.

Our estimate: Yen will stabilize between 140 and 160 to the U.S. dollar.