By Paul Blustein
Washington Post Staff Writer
Thursday, June 18, 1998; Page A01

The Clinton administration joined Japan in a dramatic rescue operation for the yen yesterday, abandoning a long-standing U.S. policy of noninterference in foreign exchange markets because of fears that the recent plunge in the Japanese currency threatens global economic stability.

The initiative boosted the value of the yen against the dollar and triggered powerful rallies in the U.S. and Japanese stock markets.

Just as currency trading was opening around 8 a.m. in New York, the two governments shocked financial markets by buying an estimated $2 billion worth of yen in exchange for dollars, using the New York Federal Reserve Bank as their agent. The move was swiftly followed by announcements in Washington and Tokyo that President Clinton had spoken by telephone late Tuesday night with Japanese Prime Minister Ryutaro Hashimoto and that Japan was pledging to take major steps to revive its faltering economy.

The operation -- the first U.S. intervention in currency markets since the summer of 1995 -- achieved smashing initial success, but many analysts questioned how long the effect would last. The yen's weakness has been blamed for driving other Asian currencies and stock markets sharply lower in recent days, deepening the region's financial crisis and sparking fears that the turmoil would spread worldwide.

The dollar-yen exchange rate plummeted 4.4 percent from the previous day's close, with the dollar changing hands at 136.37 yen in late trading yesterday in New York. Earlier this week, the rate hit an eight-year high of 146.78 yen per dollar.

Investors sent stocks prices soaring as they enthusiastically welcomed evidence that Washington and Tokyo were working together to stem the danger that Japan's economic troubles would spawn a broader crisis.

The Dow Jones industrial average soared 164.17 points, or almost 1.9 percent, closing at 8829.46 and recovering most of the heavy losses incurred Monday when worries about Asia sent share prices tumbling around the world.

Stock markets throughout Asia climbed sharply in early trading today. In Tokyo the Nikkei index surged 616.09 points, or 4.19 percent, Hong Kong's Hang Seng index soared nearly 8 percent, Singapore's main index was up 4.4 percent, South Korea's and Malaysia's jumped nearly 7 percent, and Indonesia's was up 3.39 percent.

The yen was steady in Japan, trading at 136.23 yen to the dollar.

The actions and statements by the U.S. and Japanese governments yesterday were carefully orchestrated following an intensive series of meetings and phone calls last weekend and the first two days of this week as anxiety mounted over the perils posed by the weakening Japanese economy and currency. The main participants included Treasury Secretary Robert E. Rubin, his deputy Lawrence H. Summers, Federal Reserve Board chairman Alan Greenspan, top White House officials and senior Japanese Finance Ministry officials in Tokyo.

The U.S. decision to drive down the dollar's value by selling massive amounts of greenbacks came as a particular surprise to the markets because Rubin has often declared that "a strong dollar is in the U.S. interest" and that currency intervention works only temporarily. In recent days he implied that he was strongly reluctant to help buoy the yen, asserting that changes in Tokyo's economic policies offer the only realistic hope for lifting the Japanese currency.

At a White House briefing, Rubin denied any shift in his fundamental approach, saying that the strong-dollar policy still stands and that he had acted because "the renewed weakness of the yen has had destabilizing effects on the rest of Asia."

What made intervention more acceptable to him, U.S. officials said, were pledges from the Japanese government that it would finally respond in a forceful way to Washington's repeated pleas for a cleanup of Japan's troubled banking system. Japanese banks are burdened by hundreds of billions of dollars of bad loans -- debts that are not being repaid. That problem has kept the economy stagnating for the better part of seven years, and Tokyo has resisted taking drastic steps of the sort taken by Washington during the U.S. savings and loan troubles of the 1980s, in particular shuttering insolvent institutions.

The public statements issued yesterday by Hashimoto and his finance minister, Hikaru Matsunaga, suggested that Japan was ready to change course, although they used somewhat vague language. Hashimoto vowed to "expeditiously restructure the financial system, including the prompt disposal of bad assets and the abandonment of the 'convoy' system," a reference to the practice by the Finance Ministry of forcing healthy banks to rescue ailing banks by merging with them.

Privately, the Japanese have offered assurances to Washington that Hashimoto intends to adopt some radical measures after a July 12 election for the upper house of parliament. "The details are being worked out; we are just waiting for the right time," a high-ranking Japanese official said. "You may have the impression the Japanese leadership is not aware of the magnitude of our economic problems; that couldn't be further from the truth. But the political climate doesn't allow us to take immediate steps."

Among the steps that the government will take, he said, is the use of massive amounts of Japanese government funds to buy bad loans from banks and dispose of real estate that has been used as collateral.

Japanese politicians have long feared angering voters by bailing out banks, but the official said "there is an evolving consensus among political leaders" that such steps are inevitable if the banks are to begin pumping enough new credit into Japanese businesses to give the economy a jump-start.

U.S. officials denied suggestions that the announcements in Washington and Tokyo reflected a quid pro quo -- that is, that the Clinton administration had held out for specific Japanese commitments in exchange for intervening. But in Tokyo, the newspaper Nihon Keizai reported that it was a deal: The United States agreed to the intervention only after Japan acquiesced on two points, according to Japanese government sources. One was to directly deal with bad loans. The second was to cut income taxes permanently.

U.S. officials conceded that to some extent, they are taking on faith that the Japanese will deliver. At a brief meeting with reporters, Clinton said Hashimoto "said some things which made it clear that he was prepared to take some bold steps to try to move the Japanese economy forward. You never know whether what you do in all these things will make a large difference, but I wanted to send a clear signal to the markets that the United States supports Japanese reform, believes the Japanese people can pull out of this economic slump."

Many analysts warned that unless Tokyo shows unmistakably that it is changing its policies in some fundamental way, the impact of yesterday's intervention will prove short-lived and the yen will resume its decline. "Rubin's action stopped the panic, but it won't stop the slide in the yen until Japan does something," said Richard Katz, an expert in international finance at the State University of New York at Stony Brook.

"The Japanese have been slow in responding" to U.S. pressure, agreed Steve Jonathan, a foreign exchange director for Merrill Lynch in New York, who said currency traders "will want more answers" in the days ahead about the specific actions Tokyo is planning.

Still, even halting the panic could prove a major accomplishment, because financial markets in Asia and elsewhere have been seized with fear in recent days that the problems in Japan will trigger a cascading series of currency declines.

Among the biggest worries weighing on the markets has been the prospect that China, which has held its renminbi currency stable amid the turmoil in Asia, will devalue it to make its exports more competitive and boost sagging growth. Chinese officials have vociferously complained that Washington isn't doing enough to stem the fall in the yen, and U.S. officials acknowledged that concerns about Beijing played a role in the decision to intervene, although they said they believe China will maintain currency stability out of self-interest.

A key test for the credibility of the U.S.-Japanese move will come later this week when high-level U.S. representatives will arrive in Tokyo for urgent discussions on the Japanese economic situation. The group is led by Summers, who is being accompanied by William J. McDonough, president of the New York Fed. On Saturday, Summers's counterparts from the Group of Seven industrialized nations will also meet in Tokyo, the Treasury announced yesterday, along with deputy finance ministers from a number of Asian countries.

Officials played down suggestions that the meetings might produce some new initiatives. But they said Summers will meet not only with Japanese financial officials but also with top politicians from the ruling Liberal Democratic Party. That meeting is designed to show the markets that Japan's political leaders are coming around to accepting the need for far-reaching reforms, even if they aren't ready to unveil them for political reasons.

"One major purpose is to make visible the progress of U.S. policy coordination with Japan," the Japanese official said, "and to show the contacts with LDP leaders, who are geared to make policy decisions right after the election."

Correspondent Sandra Sugawara in Tokyo contributed to this report.