BBC's Tom McMahon: Washington intends to get tough

Charlene Barshefsky, the US Trade Representative, warned Japan that the US would not tolerate unfair practices in relation to steel imports.

The US is already getting tough over trade arrangements with the European Union. It is threatening sanctions aginst EU member states as a result of an escalating argument over banana imports.

Steel imports from Japan have surged this year, contributing to a $60bn trade gap between the US and Japan.

The US Trade Representative warned the Japanese

She told a press conference that tensions were rising dramatically, and said "we were blunt in our assessment that Japan has not acted in a responsible fashion."

The US has been trying to open the Japanese markets to foreign goods for years, but has been frustrated by a lack of co-operation and more recently by the high dollar which has made US products uncompetitive.

Yen too high for Tokyo

That has changed recently as the dollar has begun a dramatic fall against the yen over the past few months - a trend that accelerated in the New Year.

By Monday the yen reached a 26-month high of ¥108.2 to the dollar - a 35% increase since the summer.

The yen reached unexpected highs

In June last year, when the yen tumbled to ¥145 to the dollar as the troubles of the Japanese economy mounted, the US Federal Reserve Bank was forced to intervene to rescue the currency.

Now the strength of the yen has forced the Bank of Japan to intervene in the currency markets, driving the rate back to ¥112.50 to the dollar on Tuesday.

The move came after Japanese finance minister Kiichi Miyazawa said he was "carefully watching moves in the yen in domestic and overseas markets".

The Japanese economy is still in recession, although the government has produced a plan to bail out its debt-ridden banks. A strong yen will make it harder for the economy to recover through export-led growth, as it makes Japan's exports more expensive.

But the US fears that bringing back a lower yen would help Japan export even more to the US, increasing the US trade deficit.

US Treasury Secretary Robert Rubin re-affirmed the US commitment to a strong dollar and denied that the US was willing to see the dollar weaken in order to help its trade problems.

"I don't think we should use the dollar as an issue of trade policy," he said.

Attractive rates

The yen has been rising because the difference between interest rates in the US and in Japan have been narrowing.

Tthe very fact that Japan's recession has forced its government to spend billions in an economic rescue package is helping the yen's rise. It has led to higher interest rates on Japanese Government Bonds (JGBs) which have attracted some investors.

Higher interest rates have also led to a decline in the speculative "yen-carry trade" which involves hedge funds borrowing in cheap yen and investing in higher-yielding dollar assets.

Dollar in trouble

The most fundamental reason for the strengthening of the yen has been the weakness of the US dollar.

The US dollar is in trouble - the US has a huge trade deficit with the rest of the world - more than $200bn (£125bn) in 1998 - which is likely to grow even bigger in 1999. Both Japan and the eurozone, in contrast, are running big trade surpluses.

"The markets have woken up to the realisation that the US current account deficit is getting larger and unsustainable," according to Gerard Lyons of DKB International.

Japanese consumers are staying away

As long as the US dollar was the reserve currency, the rest of the world was content to buy dollars to finance that deficit. But now there is likely to be a switch into euros as a reserve currency, and the yields on US assets are falling. But if foreigners, who own assets worth 15% of US GDP, sell their US assets, it could hurt the dollar even more.

The Japanese vice-minister for international finance, Eisuke Sakakibara, has described the US economy as "bubble-like", just like the Japanese economy was in the 1980s.

The US economy is expected to weaken sharply in 1999 and any further economic crisis in Latin America would hit the US hard.

Japanese worried

The Japanese Government has become increasingly worried about the rise of the yen.

Taichi Sakaiya, head of Japan's Economic Planning Agency, said the yen was at an "inappropriate level".

Prime Minister Keizo Obuchi has been in Europe trying to get support for a degree of co-ordination on exchange rates following the launch of the euro.

Last Thursday, he issued a joint statement with President Chirac calling for "a renewed framework for mutual co-operation on exchange markets, including strengthened mutual dialogue on macroeconomic policies."

But dealers were sceptical about the prospects for target zones, which are opposed by the US. The currency fluctuations are bound to be discussed in a meeting of G7 finance officials and central bankers in Frankfurt.

"True stability of the yen in the foreign exchange market can only be achieved by restoring confidence in Japan itself." said Hitoshi Imamura of Nippon Credit Bank.

For the moment, the volatility of the yen has been increasing as the currency speculation is increasingly driving its level. Some dealers believe that the launch of the euro made this worse. "Speculators are playing around with the yen more as they had to adopt a more cautious attitude to the new currency," said one dealer at a major Japanese city bank.