How US Business Leaders View the Japanese Economy

Shuichiro Hamanaka
President, Institute of Fiscal and Monetary Policy

Director Hamanaka:

Please refer to the summary of my presentation distributed earlier.

We will begin with the amendment of the Foreign Exchange and Foreign Trade Control Law. The last time the Foreign Exchange Law was amended was in 1980. Prior to that it had not been amended for 20-30 years. Those amendments came right after World War II.

It is normal for almost every country to manage foreign exchange in some manner. When the law was amended in 1980, Prime Minister Fukuda was adamant that foreign exchange transactions should, in principal, be liberalized. At the time the fixed yen/dollar exchange rate had already collapsed and the transition had been made to floating markets, but it was still a time of deep division. There were some who were of the opinion that a fixed rate would be better, while others thought that we should prepare for a full-fledged floating system. Given the times, the 1980 amendments were not necessarily as rigorous about foreign exchange liberalization as they might have been. Still, the Foreign Exchange Law did come down on the side of liberalization in principle.

Still, we subsequently encountered many problems. There was talk of a "hollowing" of Japanese markets, and there were serious problems with the separation between banks and securities companies. Then, we saw Japanese financial institutions setting up shop overseas only to come under domestic regulations when they tried to handle foreign financial products.

Several years ago this began to create a growing perception among the people in the Ministry of Finance's International Finance Bureau that the regulations on foreign exchange trading should be changed. But there was, of course, opposition to this liberalization, and one of the initial hurdles to be overcome was the need to build up the necessary momentum towards liberalization.

The solution was to make an unprecedented request to the Council on Foreign Exchange and other Transactions that it go through and review everything that needed to be accomplished for liberalization. This was not the way things were usually done. Normally if the Council were to have, say, a two-hour meeting, the first hour and a half would be spent on explanations from the bureaucracy, with the remaining half hour for questions and answers. The result was generally to create the impression that everything had been orchestrated and led by the bureaucracy. We wanted to avoid this, so we began by asking Council members to tell us frankly anything that they would like to say about foreign exchange regulation. So we proceeded in this open environment gathering the opinions of individual Council members, and what we found last spring was that the majority thought that foreign exchange regulation should be overhauled. Now that we had a basic direction, we began the process of narrowing down which specific points needed changing. The result was the report that the Council issued in January. The Ministry of Finance drafted a bill based on the report and submitted it for discussion to the Diet in March. In May, the bill was passed.

The focus of the debate was on eliminating the "authorized foreign exchange bank" system. The idea behind this system was to concentrate all foreign exchange trading in authorized banks and use them to provide legal controls on foreign exchange. However, all sorts of exceptions were crept in. The big trading houses had more than enough experience in this area, the securities companies were moving into international financial transactions like foreign exchange, and the insurance companies were investing their assets in foreign financial products. Many were therefore of the opinion that it was inadvisable to continue holding onto the "authorized bank" system. Ultimately it was decided to liberalize both foreign exchange services and also domestic and foreign capital transactions. Generally permits were always forthcoming for these sorts of transactions, but companies still had to obtain permits before they could begin. Some argued that since permits were issued anyway, there were no procedural barriers; but others responded that while everyone might in fact obtain a permit they still had to go through bothersome application procedures. Others noted the need for officials to look at each and every transaction in detail. On the other hand, prior checking gave the bureaucracy a chance to have voice its opinion on risky transactions, which was seen as a merit. Anecdotal evidence suggested that some companies used the bank or the Ministry of Finance as an excuse to cover up their own failure to complete clerical procedures in time. After discussing all of these points, we finally arrived at the conclusion that we would be better off adopting a system in which everyone is responsible for his own choices.

In exchange for a more open system, we would impose an after-the-fact reporting requirement so that the government could continue to track foreign exchange transactions. We did, however, envision a computerized reporting system, given the availability of the technology and the need to keep clerical burdens to a minimum.

Another issue in foreign exchange liberalization was what to do about the potential for Japanese funds to flow to internationally-problematic countries. Say, for example, people began sending money to Iraq or Libya, or Japanese investors were buying bonds from problem countries, how would the government respond? Or if the UN Security Council adopted sanctions calling for countries to halt the flow of funds to certain places, we would need a mechanism that would enable Japan to comply. It was decided that in emergency situations it would be possible to impose a prior permit requirement on these sorts of international transactions so long as it was widely published and clearly stated the countries and time periods involved. Other than these sorts of exceptions, I think it is safe to say that we have liberalized every aspect of foreign exchange.

When we first brought out our liberalization plans, the response was, "Can you really do it?" Last October or November the betting was that there would be a debate, that the Ministry of Finance would try to preserve its authority in some form or other. The Ministry had no such plans. When we looked at the situation at that time, we knew that we had no alternative but to press ahead. If anything, we saw this as a chance to overhaul the entire system, and that is how we explained it to the members of the Diet. Their response was, "Well, we could give it a try, but there is going to be fallout."

I think the atmosphere was changed by the US-Japan Insurance Talks. We were under a deadline to reach a conclusion to the talks by December of last year, but they were going nowhere because the US was being adamant about certain points. Its basic argument was that AIG has entrenched interests that should be maintained. The Ministry of Finance's plans to allow life and casualty insurers to compete in each others industries was just an attempt to bully AIG. We responded that opening the Japanese insurance market and allowing life and casualty insurers to compete with each other was a package deal. We would provide a transition period so that foreign insurance companies would have time to prepare, but after that period was over, everything would be thrown wide open. The US was lukewarm about this, though it continued to affirm that it was in support of the market opening. We only reached an agreement at the end of last year because of the super efforts of the Ministry of Foreign Affairs and Ambassador Sato, our ambassador to the United States, and also because of the assiduous negotiations conducted by Minister Mitsuzuka, who even came in on Sunday to negotiate in spite of the fact that during this time the budget was being finalized and he was very busy with that as well. What these negotiations did was to prove to people in Japan and around the world that we were serious about financial liberalization. I think the finance industry as well realized that the trend all across the world was towards liberalization.

Later, as we went around to the Diet members explaining our plans, their reaction was completely different than when we initially presented our plan. They would ask us if we had changed our plan. "No," we replied, "It's the same, and we intend to go through with it." "You should have done this earlier," they would say, or, "If you experience any opposition, come to me and I'll take care of it." In addition to this encouragement, we also were greeted by some surprise. An often heard comment was, "I thought it would take four or five years. I never thought you'd be able to do it this fast." Banks saw the moves positively, as a new business opportunity. Not only would the liberalization of foreign exchange allow them to launch new products, it could also have a vast impact on the way the industry operated. The trading houses were extremely cooperative. However, they received a lot of questions from smaller companies who wanted to know what fees would be like after foreign exchange transactions were liberalized or if this meant that they would be able to deal directly instead of going through the trading houses at all. Some are of the opinion that the liberalization may force the trading houses to overhaul their operations as well, in unexpected ways.

Foreign exchange will not be liberalized until April of next year, but we are already seeing the signs of change. Some of the foreign financial institutions that had fled to Hong Kong and Singapore are coming back to the Japanese market.

I would now like to turn to the Japanese Big Bang. In November of last year, Prime Minister Hashimoto instructed the ministers of finance and justice to "have the Japanese Big Bang completed by 2001." Mr. Hashimoto has himself held the finance and trade portfolios and I think that he saw this as an opportunity to finally put some of his ideas into practice.

I am sure you are already well aware of the basic concepts underlying the Japanese Big Bang: "free," "fair," and "global." I do not think we should necessarily wait for 2001. We should begin to reform our financial markets along these principles earlier if we can. Financial reforms are strongly intertwined. If you move forward with one, then it has an impact on all the others, which may create problems. The Prime Minister is well aware of these difficulties; however, he has instructed us to "do it" regardless. This, I believe, is an expression of intense resolve on his part.

The reason the Minister of Justice is involved is because financial reforms will involve broad changes in some of our basic criminal, civil, and commercial codes. For instance, we will need to overhaul corporate accounting standards and the securities trading law. We will also have to set up rules for handling derivatives.

[THE PARAGRAPH ABOVE IS CONFUSING IN WRITTEN ENGLISH. IT IS A NON-SEQUITUR; THERE IS NO ANTECEDENT, THERE IS NO TRANSITION. I SUGGEST THAT IT BE USED AS AN EXAMPLE IN THE PARAGRAPH IMMEDIATELY BEFORE IT: "If you move forward with one, then it has an impact on all the others, which may create problems. For example, the reason the Minister of Justice is involved . . . "]

The Ministry of Finance quickly called together its Financial System Research Committee, Insurance Council, Securities and Exchange Commission, and Business Accounting Council to begin the debate. The Ministry wanted all of the councils to begin and conclude at more or less the same time, so Professor Ryuichiro Tate (professor emeritus of the University of Tokyo, chair of the Financial System Research Committee) was asked to form a coordinating committee to provide general oversight of the councils' progress.*1 This was an almost unprecedented way of doing things, both for the Ministry of Finance and for Kasumigaseki as a whole.

During the course of the debate on foreign exchange liberalization and the Big Bang many commented that we would be inviting the out-flow of \1,200 trillion in personal assets, or that Japanese financial institutions would end up like British institutions after their Big Bang, scattered, their markets dominated by foreigners. However, assets move based on interest rates and risks. If the risks are equal over the medium and long term, then assets will go to where the interest rates are highest. In other words, over the course of the Big Bang, foreign financial institutions will offer products to Japanese investors and Japanese financial institutions will try to respond to that. Assets will move within the context of this competition and that is what will determine whether the Japanese or the foreign institutions win. It is therefore a bit hasty to conclude that just because foreign exchange has been liberalized that assets will immediately move overseas, or that Big Bang will cause Japan's financial markets to be taken over by foreign institutions. The key is what kind of products Japanese financial institutions will be able to offer investors. Some have also worried that part of our \1,200 trillion in personal assets will flow overseas, attracted by the high interest-rate financial products available there. But if, for example, these assets head towards Southeast Asia and China, then they will help to smooth the flow of funds at a global level.

This January, Kenneth Clark, the former British Minister of the Exchequer, visited the Ministry of Finance, where he told us, "In England, we liberalized foreign exchange in 1979 and had Big Bang in 1986. In the US, May Day came in 1975, but then they took time to make other reforms. Japan, however, is undertaking an intensive reform of its financial markets in a very short period of time. Though you have an enormous \1,200 trillion in personal assets, you are trying to have everything done by 2001. This isn't 'Big Bang,' it's 'Bigger Bang'" Certainly our reforms are broad and comprehensive, but they represent the conclusions of councils working in close coordination with each other, and I believe that we will be able to go through with them."

One of the challenges that I think we face is to get out of our normal habit of viewing financial regulation from the perspective of the government controlling industries. Instead, we must shift our perspective to the providers and users of financial services and think of government administration in these terms. This argument was made by many council members and also by many Diet members, and out of this came the valuable opinion that perhaps what was needed was a financial services law that would cover all financial industries.

Finally, I would like to touch briefly on the WTO financial services negotiations. Given the financial conditions in Southeast Asia, this is a difficult time for these negotiations to be proceeding, but a conclusion is expected in December. It is often said that Japan is in a difficult position in these negotiations because it has only just now belatedly started to open its financial markets. However, I would point out that the United States two years ago took the stance that it would withhold most-favored-nation status and has brought out a thirty-page list of reservations to liberalization. For example, a foreign bank that has come into Japan and set up an office in Tokyo does not need to get a new banking license to set up an office in Osaka. In the United States, foreign banks have to get a new banking license from each and every state in which they want to open offices. Some states like Alabama have citizenship requirements for foreign banks that want to set up operations there. Many people have the idea that US financial markets are free, but from a professional standpoint they are far behind the liberalization curve. What about the EU? There are countries like Denmark that say they will not follow EU directives, which they claim are written primarily for Germany and France. Italy and others have long lists of liberalization reservations-in Italy's case, eighty pages. Compare that to Japan's reservations list, a mere three pages, and once the foreign exchange liberalization takes effect it will go down to one or maybe one and a half pages. The other countries recognize Japan's liberalization efforts, which is why Director Okubo of the Ministry of Finance was selected to chair the WTO negotiations. Many have told us that they would like Japan to take the leadership in these negotiations. In short, the world recognizes and values Japan's efforts to liberalize.

Thank you.

Questions and answers

Q: I was impressed by your discussion of Big Bang. Does the Ministry of Foreign Affairs have any plans to actively publicize these sorts of stories. Boston is a very active city in the realm of finance and when we go around explaining Japan's plans to different institutions and organizations, there are always a few questions that we encounter.

One of them that people in the United States frequently ask is whether Japan will really see the reforms through to the end. For example, there are reports that foreign securities companies are trading more actively on the Tokyo Stock Exchange, and people in the United States fear that if in the course of reform foreign financial institutions become too active it will lead to a halt in liberalization and that the rug will be pulled out from under the foreign institutions that have set up operations in Tokyo.

Another complaint we hear from Japanese banks that have operations in foreign countries is that Japanese regulations on lending against land apply even to their activities overseas. They ask us if these regulations will be eliminated as part of Big Bang.

A (Hamanaka): I'd like to start with the second question. Certainly we had a lot of regulations five or ten years ago. Today we do not. If we have any at all, they would cover situations like, for example, a Japanese fishing company that tries to set up operations in a Pacific island country that is not a signatory to any of the treaties on conserving fishing resources. Having operations there would allow the company to get around the treaty provisions and make a lot of money in the process. Were it to come to its bank seeking a loan for this, we would advise against it. But these are cases in which common sense would lead to the same conclusion anyway. I understand that there are many cases in which the people at banks say that there is such-and-such a egulation and try to use that as an excuse for refusing the loan.

Going back to the first question, the development of financial products like derivatives requires advanced mathematics and computer technology, and this has become almost the exclusive province of people from Europe, the United States, and perhaps India. Some people say that we Japanese are just not suited to developing creative, original products. That leads many to question whether we ought to have a Big Bang at all in areas in which the Japanese have a handicap.

Our response to this is, if you really think that the Japanese are unsuited to developing products like derivatives, then why don't you just hire some Caucasians? And if you can't turn a profit developing products like derivatives, get out of the business. These are issues for individual financial institutions to decide.

I understand that nearly half the directors of Citibank are non-Americans. What is important is that we turn the Tokyo financial market into a common asset for the entire world. New York, Tokyo, and London can divide the day among them in eight-hour blocks to provide smooth market services twenty-four hours a day. Our goal is not just to enable Japanese financial institutions with headquarters in Tokyo to continue prospering off the status quo.

* 1. Redundant sentence omitted