Japan, China Locked In by Investments

By Blaine Harden and Ariana Eunjung Cha
Washington Post Foreign Service
Saturday, September 20, 2008

TOKYO, Sept. 19 -- Japan is a captive of its investment in the United States economy and its central bank has no real alternative other than to hold on to the massive amounts of U.S. Treasury bonds it owns and work hard to help clean up the mess on Wall Street, Hidehiko Sogano, an associate finance director at the Bank of Japan, said Friday.

"The reason why we stress the importance of stability is that the amount which we have in U.S. assets is so enormous," said Sogano, referring to the roughly $860 billion of the bank's $1 trillion in reserves that are in U.S. investments, mostly Treasury bonds.

Sogano spoke on a day in which East Asian stock markets sharply rebounded after days of declines. Japan's Nikkei average was up 3.8 percent, cutting in half losses for the week. The Shanghai Composite Index surged 9.5 percent, while Hong Kong's Hang Seng index was up 9.6 percent. The rises followed market-calming moves by the U.S. government that helped drive the Dow Jones industrial average up 410 points Thursday and another 368 points Friday.

Japanese banks, finance companies, shipping firms and steelmakers recorded double-digit gains. The nation's biggest nonbank financial company, Orix, jumped 16 percent, its largest increase in 24 years. The fourth-largest bank in Japan, Resona, was up 18 percent.

Just how deeply Japan is enmeshed in troubled loans in the United States became significantly more clear Friday, when Finance Minister Bunmei Ibuki conceded at a parliamentary hearing that the government and central bank hold about $74.5 billion in debt issued by mortgage finance giants Fannie Mae and Freddie Mac, recently bailed out by the U.S. government.

Sogano, who said he was speaking for the bank, is part of a team at the bank that has worked around the clock this week to calm global markets. "If we shift out of the dollar without deep consideration, then that would surely affect the market," he said. "So that is why we always have to be very careful. If that sounds conservative, it is conservative."

In a week of epochal market turmoil, for the Bank of Japan being very careful has meant being aggressively interventionist. Besides injecting the equivalent of about $96 billion in four days into money markets for overnight loans, the bank has gone into the business of making dollar loans.

It joined with four other central banks in a $180 billion currency swap with the Federal Reserve and will use its $60 billion share to supply dollars to local and foreign institutions.

Sogano said that the Bank of Japan feels that U.S. market turmoil, even if it continues for months or years, will not alter the central place the United States occupies in global finance and will not undermine the willingness of the Bank of Japan to invest in the United States. "There will be no change because we quite understand the importance of the U.S. market and the stability of the dollar," he said.

Sogano said that the bank does not support a reduction of interest rates, which are already at 0.5 percent in Japan.

The Bank of Japan will focus primarily on increasing liquidity in money markets, so that short-term rates will fall back to levels of before the turmoil of the past week and banks will again be willing to lend money to each other at the lower rates.

Ibuki, the Finance Minister, said Friday that Japan would consider funding the International Monetary Fund or other international lending agencies to help with bad debt.

Sogano said there is no political support in Japan for mobilizing the several trillion dollars in Japanese pension funds and other savings funds to recapitalize troubled U.S. financial institutions. He agreed that such investments, if properly managed, could increase returns for savers in Japan.

China, however, has signaled some willingness. As U.S. financiers scrambled this week over how to deal with possible collapse of major financial institutions, Chinese Vice Premier Wang Qishan arrived in Washington with a message: To survive the crisis, U.S. equity markets need countries such as China that have massive foreign exchange reserves to jump in a big way.

In recent weeks, finance chiefs from around the world have come to consult with their counterparts at the Federal Reserve and U.S. Treasury about possible interventions.

China's delegation, headed by a 60-year-old ex-banker who comes from the country's depressed coal-mining region, has been among the most vocal, according to sources briefed on the discussions.

China has a direct interest in the U.S. crisis. It is estimated to hold a fifth of its currency reserves -- as much as $400 billion -- in Fannie Mae and Freddie Mac debt. In addition, its banks have billions of dollars worth of exposure to the American International Group, Merrill Lynch, Lehman Brothers and other companies in crisis. The Industrial and Commercial Bank of China, for example, has $151 million in bonds issued or linked to Lehman; China Merchants Bank has $70 million of Lehman bonds; and the Bank of China has $75.62 million of Lehman bonds.

As U.S. officials were deciding in August whether to take over Fannie Mae and Freddie Mac, the Treasury Department held informal talks with officials from the People's Bank of China, the country's central bank. At that time, investors in Fannie Mae and Freddie Mac in China were dramatically reducing their holdings. The U.S. side told China that a cash infusion was in the works; China said that it expected the U.S. government to "do whatever is necessary" to protect the investments.

Accompanied by a delegation that includes senior officials from China's central bank and Ministry of Finance, as well as banking, insurance and securities regulators, Wang had originally traveled to the United States on Sept. 14 for trade talks in Los Angeles. But as new shocks hit earlier this week, Wang flew to Washington to meet with Treasury Secretary Henry M. Paulson Jr.

Wang sought assurances that if the Chinese government were to encourage its companies to seek investments in the United States, the deals would not face the same political opposition that has undone past Chinese investment proposals.

Andy Xie, an independent economist who was formerly Morgan Stanley's chief Asia economist, said the United States needs to accept that a large amount of U.S. assets must be transferred to other countries' ownership. "If the U.S. is not willing to accept that," Xie said, "they will have to print money and the dollar will fall. And we will be headed toward a global financial meltdown."

Companies in the United States and in Europe are already reaching out to Chinese investors.

Morgan Stanley chief executive John Mack has been in contact with the China Investment Corp., the sovereign wealth fund that manages $200 billion, and with China's Citic Group. La Compagnie Financière Edmond de Rothschild on Thursday announced that it had sold a 20 percent, $340 million stake to Bank of China.

It's unclear how Chinese investors will respond to the overtures, especially given that their biggest investment in Wall Street to date, CIC's investment in asset manager Blackstone Group, has turned out to be a disaster -- its investment has lost half its value.

Cha reported from Shanghai.

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