A Low, Stable Dollar Will Attract More Japanese Money to the U.S.

TOKYO —  There is a widely held belief in Washington and New York that a strong U.S. dollar will attract more foreign money, particularly Japanese money, into the U.S. bond market. There is also the belief that the Clinton administration is supporting a strong dollar in order to attract Japanese money and keep a lid on long-term U.S. interest rates.

These views, however, are based on Japanese investor behavior in the 1980s--not the 1990s.

In the 1980s, Japanese investors were chasing markets everywhere, both in Japan and abroad. In those days, markets almost always went sky-high when Japanese investors jumped in. With huge unrealized capital gains on domestic assets that could be used to offset any losses overseas, these investors were afraid of nothing and were aggressively buying everything from Los Angeles office buildings to U.S. Treasury bonds.

In the 1990s, however, after the collapse of asset prices in Japan and the subsequent disappearance of those capital gains, the Japanese have become some of the most cautious and value-seeking investors in the world.

For example, during May to July last year, when the exchange rate was in the range of 80 to 90 yen to the dollar, Japanese investors purchased $19.2 billion in U.S. bonds. That’s a huge amount, larger than the annual totals for four out of the last five years and a record for any three-month period.

However, when the dollar surged in value in August and September, Japanese investors did an about-face. After buying $3 billion in bonds in August, they sold a total of $16.8 billion in bonds from September to December, the largest consecutive net selling in history. Their October net liquidation figure of $6.6 billion was also a one-month record. Not even in the days surrounding the Black Monday stock market crash of 1987 have we seen such massive selling of U.S. bonds by Japanese investors.

What this behavior suggests is that Japanese investors are now bargain hunters. At 80 yen to the dollar, they were record buyers of U.S. bonds because they thought their downside risk was minimal at those exchange rates. At 100 yen and above, however, they were concerned about their downside risk and quickly turned into record sellers in order to lock in profits.

The figures also suggest that Japanese investors contributed greatly to the U.S. bond market rally between May and July last year. In spite of their massive purchases, however, very few Wall Street commentators noticed the Japanese presence during this period, precisely because those investors were bargain hunters. Market commentators typically talk about the Japanese as investors who buy aggressively at the top; they rarely talk about them when they are scrounging the bottom for bargains. Similarly, many people have attributed the U.S. stock and bond rallies during the last few months of 1995 to Japanese buying, when in fact they were selling.

The policy implication of all this is that in the 1990s, a low and stable dollar--where the downside risk is limited--will attract more Japanese money into the U.S. than a strong or strengthening dollar. Many investors I have talked to have said they will be happy buyers of dollar bonds at the exchange rate of 90 to 95 yen to the dollar, but not at current levels of more than 100 yen. Indeed, whereas limited purchases were made by Japanese investors in January and February, there is a risk that a strengthening dollar could trigger massive selling by Japanese investors, who still hold more than $200 billion in U.S. paper.

Many investors still do not realize that the Japanese learned their lesson chasing markets in the 1980s. For example, in 1991 and again in 1994, foreign investors, particularly U.S. investors, bought heavily into the Tokyo stock market, believing that the Japanese economic recovery was just around the corner. They were also hoping that once they kick-started a rally, Japanese investors would jump in as they did in the 1980s.

However, Japanese investors did nothing, nor did the economy recover. In other words, Japanese caution was more correct than foreign optimism in both 1991 and 1994. The fact that Japanese investors did not hop on the bandwagon suggests that now it is the foreigners who are the market chasers, not the Japanese.