Economic Report of the President

AN UNDERVALUED YEN?The explanations of the strong dollar discussed so far leave out aview which has received considerable attention—that the strength ofthe dollar reflects deliberate undervaluation of their currencies byour competitors, especially Japan. This view is important enough inits implications for U.S. international economic policy to deserve separatetreatment.Arguments that the yen is undervalued are of two types, which arebasically independent of one another. One argument is that the Japanesegovernment has persistently kept the yen undervalued. Theother is that the Japanese have only recently engineered a decline inthe yen to gain competitive advantage. Neither of these views appearscorrect in light of the actual behavior of Japan's balance of paymentsand exchange rate.If the first allegation—that the yen has been persistently undervalued—wascorrect, Japan would run persistent current account surplusesin excess of what seems justified. We would also expect Japanto have experienced exceptionally rapid growth in its foreign exchangereserves. Neither of these was the case:• From the beginning of floating exchange rates in 1973 through1981, Japan had an average surplus in its current account of only0.15 percent of GNP. This was not much more than the U.S.figure for the same period (0.11 percent), considerably less thanthat of Germany (0.47 percent), and much less than the U.S. surplusof the early 1960s (0.70 percent).• From the beginning of floating exchange rates in 1973 to thethird quarter of 1982, Japan's reserves minus gold grew at anannual rate of 4.8 percent, far less than the 9.7 percent rate ofreserve growth for all non-OPEC countries.These facts contradict the view that the yen was persistently undervalued.There remains the possibility that the yen's weakness duringmuch of 1982 was excessive in some sense. A natural question iswhether, after adjustment for purchasing power parity, the yen fellmore against the dollar than other currencies. The answer to thisquestion depends on the base period used for comparison. For mostbase periods, however, the real depreciation of the yen against thedollar appears smaller than that of the French franc and the Germanmark. Table 3-5 shows an illustrative set of numbers. As the tableshows, only for a few base periods does the yen appear more "undervalued"than the other two currencies.The actual behavior of the Japanese balance of payments and exchangerate thus do not support the view that there is any special undervaluationof the yen—that is, they suggest that exchange-rate65