The Wall Street Journal-20080213-Politics - Economics- Japan Debates Jumping into Sovereign-Wealth Pool- Huge Reserves Pile Would Back Fund- A Hit to the Dollar

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Politics & Economics: Japan Debates Jumping into Sovereign-Wealth Pool; Huge Reserves Pile Would Back Fund; A Hit to the Dollar

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TOKYO -- As Japan watches its Asian neighbors grab headlines with investments made through their government-controlled funds, it is debating starting one of its own, backed by its huge reserves of foreign currency.

The discussions still are at an early stage, and lawmakers promoting the idea already face opposition from the Finance Ministry, which wants to continue managing Japan's currency reserves conservatively. At the end of January, Japan's reserves hit a record $996 billion -- making them the world's second largest after China's $1.4 trillion -- but the majority of them are parked in U.S. Treasury bills, economists said.

Still, the creation of a Japanese sovereign-wealth fund, or state- controlled investment arm, would be a departure for the nation and could have significant impact in the global financial markets. Such a fund probably would invest in a wide range of assets from stocks to bonds in various countries. As a result, Japan's appetite for U.S. bonds and dollars would likely wane over time. That could further weaken the dollar, at a time when many investors, to diversify their currency holdings, already are shifting money from dollar-based assets to those denominated in the euro and other currencies.

"The full development of a sovereign fund in Japan is more influential on the Treasury market and other dollar assets" than other sovereign funds, says Stephen Jen, global head of currency research at Morgan Stanley.

The debate comes as Japan struggles to find ways to energize its economy as it starts to feel the impact of a U.S. economic slowdown. With its near-zero interest rates and hefty fiscal deficit, Tokyo can't depend on conventional monetary or fiscal policy to spur growth. Instead, lawmakers and economists are looking for ways to make use of the nation's ample savings from the past, such as its citizens' retirement savings or the government's emergency stash, to help boost the economy.

"Up until now, Japan's policy has focused on trying to boost people's income," said Yuji Yamamoto, a member of the lower house of Parliament and a former financial-services minister. "Now we need to find ways to make our assets work harder so we can feel wealthy."

Mr. Yamamoto, along with Yoshimi Watanabe, the financial-services minister, lead a group of ruling-party lawmakers who are pushing for more aggressive management of government-controlled funds, including money in the national pension system. The group was formed in December with just 40 members but has increased to include nearly 100 lawmakers, Mr. Yamamoto said.

The first area they want to tackle is Japan's foreign-currency reserves, accumulated over many years. The reserves generated some $33 billion alone in interest and dividend income in the fiscal year ended March 2007

As an initial step, Mr. Yamamoto wants the government to set aside some 200 billion yen, or about $1.9 billion, from that interest income and set up an investment fund. The fund would then be managed by four selected private asset managers. "We want to bring in fund managers from the major leagues, from New York, London and Singapore," Mr. Yamamoto said.

Mr. Yamamoto's group has started researching the topic, and he will put together a report to Prime Minister Yasuo Fukuda recommending creation of such a fund later this year.

Officials at the Finance Ministry, which is considered the biggest obstacle to the effort, said the country's foreign-currency reserves need to be managed conservatively because these government assets could be used to help offset the country's budget deficit. Another reason for its reluctance to consider other investments: Diversifying assets would involve selling dollars, which in turn would boost the yen. A strong yen could hurt Japan's export-oriented economy by making Japanese products more expensive overseas.

Finance Minister Fukushiro Nukaga said earlier this month that at this point he didn't think such a fund would be created in Japan, citing the possibility of losses resulting from risky investments.

Creating such a fund without the ministry's backing would require Parliament to approve a law authorizing the move.

Still, some experts said the government is taking a bigger risk by keeping so much of its reserves in U.S. Treasurys. Those returns reflected what for years was a widening gap between low Japanese interest rates and higher U.S. rates.

Now, with the Federal Reserve cutting interest rates as it tries to stave off a recession, that gap is shrinking. In addition, the yen- based value of the reserves, which have been increasing over the past several years as the dollar strengthened against the yen, have begun to unravel recently as the dollar has weakened against the yen.

"Keeping all the assets in dollars is against the basic rules of finance," said Takatoshi Ito, an economist with the University of Tokyo and a member of the prime minister's policy advisory board. The Finance Ministry "is letting the risk grow progressively."