have huge unrecognized losses, and the industry has a regulatory culture of cozy relationships that contrives to postpone recognizing or addressing problems, and routinely obfuscates material information when those problems, one way or another, surface. This regulatory culture is a natural outgrowth of the country's culture, which, in its zeal to save face, refuses to acknowledge mistakes of the immediate, and even distant, past. With a splintered government, there is no near-term prospect of strong leadership moving the country to accept political and social change. With regard to banking, an important manifestation is a refusal to establish a taxpayer-backed safety net for failing banks in order to protect depositors. All of the above is widely known. In addition, the recent disclosure of unreported security trading losses of $1.1 billion at the New York branch of Daiwa Bank, and, worse still, the delayed reporting to U.S. banking officials, heightens concern and raises questions as to how many more such losses may exist and at which other banks. The international financial markets' reaction has been to assess a premium on the rates charged to Japanese banks for interbank loans. The premium is large, up to about 60 basis points, depending on the institution. More serious has been the growing reluctance on the part of interbank lenders to extend funds to Japanese institutions, despite the premium. The new credit facility established by the Federal Reserve with the Bank of Japan and, apparently, other major central banks as well, will only serve to bridge a relatively brief period of credit insufficiency. The facility is not intended to solve the fundamental issues described above. The Japanese monetary authorities have two basic remedies to deal with the immediate banking problems. One is to "guide" Japanese banks to reduce their overall dollar-denominated balance sheets. By doing so, Japanese banks may be able to mitigate the problem, and the premium may be narrowed. In any case, with the premium so high, the dollar portion of Japanese banks' business may, in fact, be losing money. A second remedy has been a reliquefying of the Japanese financial system. High-powered reserves and narrowly defined money in Japan are now growing very rapidly. These approaches should have important effects on the U.S. banking system and Japanese-American financial relationships. A downsizing of the dollar portion of Japanese banking business should reduce, or even eliminate a large and very competitive lender from the market. Japanese banks are known to lend at very tight spreads. As a result, other lenders may be able to capture business at slightly wider spreads in the new dollar-lending regime. Borrowers will still have adequate funds available to them, but the costs might be marginally higher. A second major impact is likely to be on the exchange value of the yen. Since the money supply is growing faster than the economy and is likely to continue to do so, and since interest rates in Japan are very low, Japanese investors are likely to have a lot of money to invest, and are likely to invest it abroad. Obviously, the United States is an attractive area of investment. The movement of yen into dollars should strengthen the dollar and weaken the yen. The decline of the yen is likely to be an important stimulus to the Japanese economy, the mirror image of the depressant imposed by the strengthening yen earlier. Indeed, the weaker yen and greater competitiveness of Japanese products, internally and abroad, may be an important locomotive for the overall Japanese economy. Thus, in our view, the dollar is headed higher, especially against the yen - a lot higher. There are likely to be domestic consequences. The weakening of the dollar against the yen was a component of the U.S. strategy to force Japan to open its markets while making American goods more competitive. A strengthening dollar would erode the price competitiveness of American goods. That could encounter resistance by American producers and workers, especially the new leadership of the AFL-CIO. John J. Sweeney, the new president of that union, is likely to have some leverage with the Clinton administration, especially in an election year. In fact, once the election is over, the leverage is likely to weaken, so 1996 may be Mr. Sweeney's best hope. Thus, a coalition of interests, led by the union and joined by some major producers, may pressure the Clinton administration to reverse its latest policy of favoring a strong dollar. Ultimately, we believe the economics of the situation will overpower the politics. But this is an area that will command attention for quite some time.
