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China's Yen Buying Riles Japan

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1 China's Yen Buying Riles Japan on Fri Sep 10, 2010 7:37 am


China's Yen Buying Riles Japan
Currency Matter Complicates Ties Already Frayed by Other Disputes

Sept 10,2010


Tokyo raised the heat on Beijing for contributing to a strong yen, adding to tensions between Asia's two largest economies.

As the yen hovered near a 15-year high against the U.S. dollar Thursday, Japanese Finance Minister Yoshihiko Noda called for talks with China over its recent yen-buying spree, which has helped drive the yen higher, making Japanese goods less competitive with China's.

Mr. Noda's comments, while perhaps aimed at a domestic audience, are nevertheless a sign of frustration among China's neighbors. Their currencies increasingly have become coveted by China as it seeks to diversify its massive reserves and reduce its reliance on the dollar. At the same time, China's critics, not least in the U.S., have long said it is giving an unfair advantage to its exporters by holding down the level of the yuan.

Chinese buying is just one factor in the yen's strength, but it has important psychological overtones—as does any shift in China's use of its foreign-exchange reserves. Private investors, sensing that China's moves could continuefor some time, have followed into the strong yen trade.

Japanese government data this week showed China's 2010 yen purchases continued in July and now equal $27 billion, more than six times China's combined yen buying in the previous five years.

"I don't know the true intention" of China regarding its growing appetite for yen-denominated bonds, Mr. Noda said Thursday before the Japanese parliament's upper house. He promised Tokyo would "closely cooperate" with Beijing on the subject. "We are paying close attention," Mr. Noda said.

The currency issue adds another complication to the China-Japan relationship, which already was on the boil this week.

On Thursday, China stepped up its rhetoric over Japan's arrest and possible prosecution of the captain of a Chinese fishing boat. The vessel had collided with Japanese patrol vessels near a chain of islands both nations claim.

Jiang Yu, spokeswoman for China's Foreign Ministry, blasted the arrest, saying that the use of Japanese law to address actions in disputed territory is "absurd, illegal, and invalid."

"Disputes over sovereign territory are highly sensitive," Ms. Jiang said. "Handled improperly, it could cause a serious shock to overall China-Japan relations. The Japanese side should clearly understand this."

China's Foreign Ministry twice this week summoned the Japanese ambassador in Beijing, Uichiro Niwa, to complain about the incident, which caused no injuries and minor damage.

The likelihood of a trial for the 41-year-old captain Chinese captain, Zhan Qixiong, increased Thursday, as the Japanese coast guard handed him over to prosecutors for further investigation to decide whether to officially charge him in the case, the Associated Press reported, citing Japan Coast Guard spokesman Masahiro Ichijo.

The incident threatens to arouse strong nationalist sentiment on both sides, especially in China, which has seen periodic outbreaks of public anger against Japan. In early 2005, several small incidents, including the approval of a nationalist history textbook in Japan, triggered a string of anti-Japanese riots, some of them violent, in major cities including Beijing and Shanghai.

Leaders of both countries also recently traded barbs over the wages Japanese factory owners pay to Chinese workers, an issue that boiled over into a series of strikes over the summer. Japanese Foreign Minister Katsuya Okada said in an interview last week that China risks losing foreign investments unless it introduces more transparency and consistency into its business rules .In May, in a separate interview, Mr. Okada also expressed reservations about China's growing military muscle, a concern that has complicated the issue of U.S. military personnel stationed on the Japanese island of Okinawa.Relations between China and Japan have swung frequently between tension and accommodation over the years as China's power has grown rapidly and that of Japan has waned. China is on pace to surpass Japan this year as the world's second largest economy after the U.S.

A more protracted economic conflict from China's role in the yen's rise is unlikely, however, as deepening trade links draw China and Japan closer together.

Japan's trade with China, its largest trading partner, totaled about $27.4 billion in July, according to Japan's Ministry of Finance. The value of Japan's exports to and imports from China is roughly equal, making China both a key producer of goods sold in Japan and a significant consumer of Japanese products. Among other industries, Japanese auto makers have increased investment in China in recent years to better compete with inroads made in that market by global rivals like General Motors Co. and Volkswagen AG. China, in turn, relies on Japan both for exports and as a source of foreign investment.

Christian Carrillo, head of Asia-Pacific interest-rate strategy for Société Générale in Tokyo, saw Mr. Noda's words as more "for domestic consumption purposes" than a shot across the sea at China. "Noda wanted to be seen to do something, because everyone is screaming at the government to act."

In addition to China's yen buying, Analysts say the yen buying is part of China's broader effort to diversify its $2.5 trillion reserves away from dollars. South Korea recently reported increased Chinese buying of its currency. The moves haven't resulted in a won bounce, but The won has traded relatively flat versus the dollar since the disclosure in mid-August. South Korea has had to intervene to keep its currency from rising against the dollar to protect the competitiveness of its exports against China's.

Ms. Jiang, the Chinese Foreign Ministry spokeswoman, on Thursday repeated Beijing's position that in managing its reserves, China is "undertaking a diversified strategy under the principles of security, liquidity, and returns," adding that the foreign ministry isn't directly involved in reserves management. China's State Administration of Foreign Exchange, which administers China's reserves, doesn't comment on specific holdings.

In the past, Mr. Noda welcomed Chinese buying of yen because it diversifies the investor base for Japan's massive government-borrowing needs. But with the Japanese economy slowing and the yen soaring, the government is under pressure by exporters and some opposition politicians to take action.

While Chinese buying contributes to the yen's strength, tThe underlying reasons for the currency's rise are varied. A slowdown in the U.S. economy and expectations that the Federal Reserve will be aggressive in keeping interest rates low have weakened the dollar. Currencies with lower interest rates tend to weaken against currencies with higher ones.

Japan's persistent current-account surplus also aids the yen. For example, China bought $7 billion of yen in July, while Japan's current-account surplus was $20 billion that same month.Mr. Noda pledged to bring to the Chinese leadership his frustration over China's heavily managed capital account, which restricts foreign buying of local-currency securities. "While China can buy Japanese bonds, Japan can't buy Chinese government bonds using its foreign reserves. I feel that's unnatural," Mr. Noda said.

Mr. Noda's more strident rhetoric did little to convince investors that Japan has the firepower to stop the yen's ascent. "The market is fed up with warnings," said Yoshinori Nagano, a senior strategist at Daiwa Asset Management.

The dollar traded at 83.82 yen late Thursday in New York, down from 83.92 yen late Wednesday. The dollar is down about 10% against the yen this year. Because China has effectively kept the yuan pegged to the dollar, the yuan has fallen against the yen by a similar percentage.

Many investors expect the yen's strength to continue. Bank of America – Merrill Lynch currency strategists expect the dollar to fall to 81 by the end of the year and Nomura recently lowered its forecast for the dollar to fall to 80 in the next few quarters.

How to deal with the yen's rise is a major policy challenge facing Tokyo. Exporters say they are losing out to rivals overseas and are looking to relocate facilities to cheaper countries—including China—to cut costs.

Mr. Carrillo is doubtful Japan's engagement with China over its yen purchases will lead to a change.

China has slightly loosened restrictions on foreign ownership of its currency in recent months, but isn't likely to give Japan enough access to Chinese securities to counterbalance the effect of its yen buying.

Japan is even more unlikely to restrict its open capital market by forbidding Chinese purchases of Japanese bonds, which could have a chilling effect on international investment. "They'd have to change their own regulations, which they aren't going to do," Mr. Carrillo said.

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