If money talks, then it might be time to learn Japanese. The dollar’s premier position in the world monetary system, held since the Bretton Woods Conference of 1944, is eroding. One Japanese yen may be worth less than one U.S. cent, but that yen is becoming a super-currency of the late 1980s.

Don’t panic. The dollar is not about to become Monopoly money. Two-thirds of the world’s official monetary reserves is held in dollars, and 70% of world trade is still conducted in U.S. currency. Though the Japanese think those percentages are too high, no kamikaze attack on the dollar is under way. There is some hyperventilated talk just below the surface in the Japanese financial community about dumping dollars or requiring all of Japan’s exporters and importers to deal only in yen. But you won’t hear any of this in government ministries. The wiser heads there realize that such moves would create panic among Japanese investors, who hold billions of dollars, and put crushing pressures on Japan’s financial markets.

What the government is talking about is a much larger worldwide role for the yen. Anxious to avoid any sense of crisis, Japan’s top bureaucrats say that increased use of the yen is simply a catch-up exercise to pull the currency into line with Japan’s greater economic might. Toyoo Gyohten, Japan’s dapper vice minister of finance, believes that a currency reflects the economic strength of the nation that issues it. Says he: “In relative terms, the U.S. is declining. It was 40% of world GNP, now it’s 25%. In absolute terms, of course, it is still the world economic power. But it’s not stabilizing to have the world monetary system so dependent on the dollar. It is our task to make the yen more readily usable for both borrowers and users.”

At a meeting of the International Monetary Fund in Berlin this September, Satoshi Sumita, governor of the Bank of Japan, urged his august audience “to consider ways of diversifying reserve currencies to complement the dollar’s key role.” Back home, Sumita’s speech got raves. Yoh Kurosawa, deputy president of the powerful Industrial Bank of Japan, called it the “most significant, boldest proposal Japan has ever made on monetary issues.”

Because of the huge sums involved, nothing will happen overnight, nor should it. A swift international rush to the yen could undermine Japan as much as any other country. But here’s what to expect:

• More of the Japanese goods that nations import will be priced in yen, including cars and electronics. Some non-Japanese commodities, like oil or gold, may start trading in yen. This could lead to higher U.S. retail prices and slimmer retail margins as American merchants struggle with exchange-rate uncertainties.
• With more yen circulating, multinational companies will want lines of credit in yen, making Joe Corporate Treasurer’s life trickier. To keep up with the growing demand for yen financing, more and more Japanese banks will begin operating in the U.S.
• Tokyo’s capital markets could eventually develop the depth and diversity of New York’s. Wider use of the yen would require a longer menu of attractive, negotiable government securities and further deregulation of financial markets. The yen could become as attractive as the dollar to traders, investors, and bankers. This wouldn’t necessarily be good for Japan: Japanese interest rates could fluctuate a lot more, making the economy harder to control.
• As the leading banker to the fast-developing Asian economies, Japan will preside over an emerging yen bloc that could eventually rival North America and Europe. (For more on the development of regional economic powerhouses, see Wealth.)

To help understand the changes taking place, some definitions are in order. A reserve currency is one held by central banks to meet their foreign obligations. A key currency is one widely used in international trade and finance. For more than two decades after Britain’s John Maynard Keynes and U.S. Secretary of the Treasury Henry Morgenthau Jr. hammered out the postwar monetary system in Bretton Woods, New Hampshire, the dollar was both. Washington agreed to exchange dollars for any foreign currency at a fixed exchange rate, and nearly all the world’s commodities were bought and sold with greenbacks.

In theory a reserve currency should be stable, and since fixed exchange rates were abandoned in 1971, the dollar has been anything but. It is the sharp decline of the past three years that is bugging the Japanese. Says Kurosawa: “If the U.S. shows its intention to keep the value of the dollar stable, then it’s okay, no problem. But the dollar has declined by half against the yen, and it’s still a key currency. A key currency shouldn’t act like that.”

Some American economists argue that ever since exchange rates were allowed to float, the U.S. has not really had an obligation to stabilize the dollar. But that is no consolation to Japanese investors who have suffered big paper losses on dollar holdings. They hold an estimated $85 billion of U.S. government securities, often buying as much as 25% to 30% of the quarterly U.S. bond auctions. Though the reasons behind the dollar’s drop are complex, Japanese investors increasingly have fixated on the the U.S. budget deficit as the main cause of their losses.

Indeed, in Tokyo’s corridors of power, both government and private, officials and executives worry constantly about the U.S. budget deficit and the weakness of the U.S. dollar. Bureaucrats admit they are powerless to stop a run on the dollar if it really gets going. Says a Bank of Japan official who asks not to be named: “The concern here is international. The dollar is not held just by us, but by the whole world. If it fell freely, it would shake the very core of the world financial markets. All kinds of unhappy things could happen.”

With these fears in mind, the Japanese are promoting the use of their own currency as a way of expanding the multicurrency reserve system in order to lessen the importance of the dollar. Says Susumu Taketomi, senior economist at IBJ: “We can’t use naked, crude expressions. What we are trying to say is that the core issue must be kept in mind—the U.S. budget deficit. If it can be resolved, the market gains confidence, and there is no need to diversify key currencies.”

Japan has hopes that greater use of other currencies, specifically the deutsche mark and the European Currency Unit (ECU), will also reduce the dollar’s role in Europe. The West Germans, though, appear reluctant to promote their currency any further—it’s already in much wider circulation than the yen. The ECU, for its part, is likely to remain more of an oddity than a currency for the time being, since Britain remains dead-set against the quasi-fixed exchange rates built into it. So if any currency is to grow in usage over the next few years, it will likely be the yen.

Meanwhile, the dollar’s leading role is steadily slipping. Since 1978 the percentage of central bank reserves held in dollars has dropped from 76% to 67%. Taiwan, Singapore, and Indonesia have all reduced their dollar reserves this year in favor of higher yen holdings. International bank deposits in dollars slumped from 76% in 1984 to 58% last year, while the deutsche mark jumped to 14%, the Swiss franc to 7.6%, and the yen to nearly 6%. At the same time, the $200-billion-a-year international bond market saw the dollar dethroned last year, with the percentage of bonds denominated in dollars eroding to a market share of 38% while yen-denominated offerings rose to 14%, outranking the Swiss franc and the deutsche mark, among other currencies (see charts).

Officials in Japan point out that the remaining barriers to wider use of the yen are strictly Japanese. Exporters have long stuck to pricing in dollars, for example, in order to curry favor with their American customers. They may no longer need to do so. Says IBJ’s Kurosawa: “I tell manufacturers it will be no problem to switch. There might be resistance from the U.S., but it depends on the real competitiveness of our goods. We would have to be even more competitive.”

The shift to yen is going to shake up a lot of corporate finance executives in the West. Says Eric Rasmussen, economist for the securities firm of Jardine Fleming in Tokyo: “The challenge will be educating American corporate treasurers to think in terms of yen. Some do, some don’t.” For those who don’t, Japanese banks are getting ready to provide help. Says Tomoyuki Shiotani, director and general manager of Yasuda Trust & Banking ($74 billion in assets): “Japanese banks will have to increase their presence in the U.S.” He says Yasuda is looking for an American bank to buy a stake in or purchase outright: “We’ll spend anywhere from $100 million to $3 billion. We don’t care about size, we want someone good.”

On the other side of the equation, those who sell goods to Japan can increasingly expect to be paid in yen. Some trading partners will welcome this. Japan’s Asian neighbors want to be paid in yen so they can pay the interest on their yen-based loans more easily. This greater use of yen in the Pacific region, through increased aid and investment from Japan and increased exports to Japan, will eventually knit together a yen bloc. Says a senior government official who asks not to be named: “We cannot announce its formation, nor can we officially promote it. But it will surely emerge.”

The Japanese are also beginning to think that they may have to abandon the dollar in paying their $28-billion-a-year oil bill. Some oil-producing countries would like to be paid in yen, and Tokyo importers appear to be ready to accommodate them. With more yen sloshing around the world, analysts in Tokyo expect the emergence of large Tokyo-based commodity exchanges, perhaps on a par with the Chicago Mercantile Exchange or the Rotterdam spot oil market.

If these types of yen trades are going to take off, however, finance minister Kiichi Miyazawa has a lot of work to do. Investors need access to plentiful, easily negotiable financial instruments that can be turned into cash instantly. At the moment Tokyo’s financial markets are about as liquid as a bowl of red beans. Ron Napier of Salomon Brothers in Tokyo calls Tokyo the “one-bond bond market.” For a variety of reasons, some regulatory, some historical, only one government bond trades actively at a time. Holders of other bonds can be hard-pressed to find buyers. Short-term interest rates are still regulated. The rules governing the issuance by foreigners of corporate bonds denominated in yen (called Samurai bonds) are so strict that most companies prefer to issue them in Europe.

Vice minister Gyohten says that all these shackles are slated for removal. “I have no intent to retard or discontinue deregulation, only to be prudent,” he says. “I want the Tokyo markets to be as liquid as New York.” How soon? Don’t start moving your money quite yet. Gyohten says the financial services industry is different from other industries. “It’s more of a public utility, compared to simple manufacturing. Its most crucial ingredient is trustworthiness. Once that is broken, it takes time to restore.”

The person with perhaps the best perspective on all this is Shijuro Ogata, former deputy governor of the Bank of Japan and now deputy governor of the Japan Development Bank. Says Ogata: “We are being forced to catch up. As a result, the yen’s role will increase—how much or how quickly, I don’t know. It depends on our deregulation efforts and on the strength of our currency. But things could move beyond our expectations. The pace of change in the past three years was much quicker than we expected. Just as water goes from high places to low, money goes from regulated to liberalized markets.” Will Tokyo be flooded? Not likely. It is in Japan’s own interest to make sure the pace of change is an orderly one.

Reporter associate: Mark Alpert