Now Japan is talking about diversifying out of dollar

Japan Should Diversify Reserves,
Prime Minister's Adviser Says

By Shigeki Nozawa
Bloomberg News Service
Wednesday, July 11, 2007

http://www.bloomberg.com/apps/news?pid=20601087&sid=at1OmRjIJsKU&refer=home

TOKYO -- Japan, the largest overseas holder of U.S. Treasuries, should invest $700 billion of its currency reserves in higher-yielding assets such as stocks and corporate bonds, said Takatoshi Ito, an adviser to the prime minister.

The reserves should be managed by a special fund that will gradually diversify into euros, Australian dollars, and emerging-market currencies, Ito said in an interview in Tokyo.

Central banks in South Korea, China, and Taiwan have announced plans to buy assets with higher returns than U.S. debt, contributing to a 7.2 percent drop in the dollar against the euro in the past year. The establishment of sovereign wealth funds, pioneered by Singapore in 1981, may also reduce demand for Treasuries, pushing up U.S. borrowing costs.

"Japan should make more use of its reserves, following Singapore's example," said Yuji Kameoka, senior economist and currency analyst at Daiwa Institute of Research in Tokyo. "To manage these funds safely, a more appropriate amount is $300 billion."

The dollar reached a record low of $1.3784 per euro yesterday, and was little changed at $1.3744 at 10:21 a.m. in Tokyo, on speculation loan defaults among home owners with poor credit histories will weigh on the U.S. economy. The yen traded at 121.73 per dollar, after reaching a one-month high of 120.99.

...A carry trade

Ito said that the Ministry of Finance, which expanded its currency reserves by selling yen in 2003 and 2004, has essentially borrowed the funds from the Japanese people.

"Foreign currency reserves are assets that belong to our citizens," Ito said in an interview July 6. "The government has borrowed the money from the people and it is engaged in a kind of carry trade. So it has to show some higher return on the investment."

Ito, a member of Prime Minister Shinzo Abe's economic advisory panel, may need to overcome opposition from the finance ministry. Carry trades involve borrowing yen to invest in higher-yielding assets overseas.

"I'm aware of the ongoing debate," Hiroki Tsuda, the top- ranked vice finance minister, said in an interview this week. The government is studying how other nations manage their reserves, though it has no immediate plans to make any changes to it own holdings, he said.

...Selling treasuries

Japan's $913.6 billion of reserve holdings are the world's second largest after those of China, which is setting up a fund to manage part of its more than $1.2 trillion of reserves. China's planned state investment fund has already agreed to take a stake in U.S. private-equity fund Blackstone Group LP.

The Government of Singapore Investment Corp. invests more than $100 billion of the city-state's reserves in stocks, bonds, real estate, and commodities. Singapore held $144 billion in reserves at the end of June, up 12 percent from a year earlier.

Japanese investors sold $84.6 billion of Treasuries since August 2004, cutting their holdings to $614.8 billion, according to the Treasury Department. Taiwanese investors sold $6.2 billion in that period, reducing their holdings to $59.3 billion.

About $200 billion of the reserves should be invested in corporate debt or mortgage-backed securities, $200 billion in stocks and the rest in other assets, said Ito. Japan needs about $200 billion dollars as its official reserves, held in highly-liquid assets such as Treasuries, to step into the market in case its currency plummets, Ito said.

"Japan should have certain levels of reserves so it can fend off unusual speculative moves," he said. The new fund would not be counted as foreign exchange reserves in statistical data but would be used for national emergencies, Ito said.

According to the International Monetary Fund, the U.S. dollar accounted for 64.2 percent of the world's foreign reserves at the end of March 2007, an eight-year low. The proportion of the euro rose to 26.1 percent, the highest since the currency was introduced in 1999.

...Global trend

On July 3 Financial Services Minister Yuji Yamamoto told reporters in Singapore that Japan should invest pension and foreign reserves in riskier assets such as stocks, the Nikkei newspaper reported. Finance Minister Koji Omi said on June 29 that reserves are not funds to be invested in a risky manner.

Economic and Fiscal Policy Minister Hiroko Ota, who heads the key economic panel, said on July 6 that "nothing has been decided about what the panel will discuss." She said the panel's special task force will continue to debate public fund investment.

While Japan hasn't intervened in the foreign exchange market since March 2004, its foreign reserves have been increasing due to growing interest income. Japan sold a record 20.4 trillion yen ($165 billion) in 2003 and 14.8 trillion yen in the first quarter of 2004.

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