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JPRS-JAR-87-005

2 NOVEMBER 1987

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JPRS-JAR-87-005

2 NOVEMBER 1987

EAST ASIA

JAPAN

CONTENTS

MILITARY

Self-Defense Forces' Air Combat Capabilities Discussed

(Isao Miyamoto; GUNJI KENKYU, May 87) 1

Reorganization of Ground Self Defense Force Divisions Seen

(Tetsuo Kawamoto; GUNJI KENKYU, May 87) 10

ECONOMIC

New Japanese Amada Plant in France, Technical Center in FRG

(HANDELSBLATT, 25 May 87) 17

Amada Technical Center 17

Punch-press Production in France, by Andreas Gandow 17

Study on Dynamics of Foreign Exchange Rates

(Kenichi Ohmae; THE JAPAN TIMES, 29 Jul 87) 21

MOF Tax Bureau's Role in Revising Taxation System Discussed

(SENTAKU, Feb 87) 39

/7310
MILITARY

SELF-DEFENSE FORCES' AIR COMBAT CAPABILITIES DISCUSSED

Tokyo GUNJI KENKYU in Japanese May 87 PP 62-71

[Article by journalist Isao Miyamoto]

[Text] As the second year of the fiscal 1987 Mid-term Defense Buildup Plan, it

is an important year for setting the course for success or failure in the

achievement of goals. The Japan Defense Agency (JDA) will procure a total of

108 aircraft in FY 1987- The breakdown of this 108 aircraft is 32 for the

Ground Self-Defense Force (GSDF), 35 for the Maritime Self-Defense Force

(MSDF), and 41 for the Air Self-Defense Force (ASDF).

Fiscal 1987 is also a year in which there will be great progress in

replacement of mainforce aircraft in the ASDF and MSDF. There are a total of

10 interceptor-fighter units possessed by the ASDF. As of tne end of fiscal

1986, there were four F-15J squadrons to five F-4EJ squadrons. Currently, one

squadron is undergoing renovation in aircraft type from the F-4 to the F-15

and the changeover will be complete in fiscal 1987, making a balance of five

to five in the strength ratio of F-4»s and F-15's.

In the case of the MSDF also, they will possess 39 each of P-2J and P-3C at

the end of fiscal 1987, a perfect balance in the aspect of number of aircraft.

The relationship is reversed in the flight squadrons with three P-2J squadrons

to four P-3C squadrons. The generation replacement of mainforce aircraft is

proceeding steadily.

In the GSDF, on the other hand, the second anti-tank helicopter squadron has

been formed and full-scale personnel training has begun for the CH-47J

transport helicopter. Tnere is only one aircraft, but deployment of tne CH47J is being made to the 1st Helicopter Group.

Below, a review will be attempted on Self-Defense Force aviation in fiscal

1987 when the transformation is completed with the replacement of mainforce

aircraft and introduction of new aircraft. First, let's begin with the ASDF

where aircraft holds a relatively high importance.
ASDF

A total of 39 aircraft of various types will be procured by the Air SelfDefense Force in fiscal 1987. The breakdown is 12 F-15J/DJ interceptorfighters, 3 C-130H transports, 20 T-4 intermediate trainers, 2 CH-47J

transport helicopters, and 2 V-107A rescue helicopters. In addition, it

should be noted that the measures to upgrade the capability of the F-4EJ

interceptor-fighter, which had been a pending issue, was moved to

implementation and the mass remodeling of 8 aircraft was approved.

In unit operational items, the 303d Squadron will complete conversion to F-15J

during fiscal 1987 and by this, the balance sheet occupied by F-4's and F-15's

in interceptor-fighter squadrons will be equal. This 303d Squadron is the

first unit to convert from the F-4J to the F-15J.

Similarly, the new formation and inauguration of the "Emergency Iruma

Helicopter Transport Unit" directly under the Central Air Defense Force is

scheduled in the third and fourth quarters of fiscal 1987. This "Emergency

Iruma Helicopter Transport Unit" is the unit in charge of CH-47J terminal

transport helicopter operations.

From the aspect of instructional training, it is noteworthy that the annual

flight time for fighter pilots has been increased 10 percent. The 146.5 hours

per person in fiscal 19tf6 has been increased to 160.5 hours this fiscal year.

The Air Self-Defense Force intends in the next 10 years to have fighter pilot

flight time at 180 hours, on par with NATO air forces, and following last

year, it has taken the first step toward 180 hours. It can be appreciated as

an indication of a bright outlook for the future.

Procurement and Deployment of Aircraft

As stated before, 12 F-15's will be procured in fiscal 1987. The breakdown of

the 12 aircraft is 6 each single-seaters and two-seaters.

Among the 6 F-15J's procured in fiscal 1987, 4 are required to make a 22-

aircraft formation from the current 18 aircraft as the authorized number for

F-15 squadrons of the 2d Air Wing (Chitose Air Base). The remaining two will

be transferred as spares. The increase in the authorized number of aircraft

for squadrons is to deal with the increase in the number of scrambles in

recent years. It is considered difficult to conduct training with the current

18-aircraft system and the increase has been greatly desired for sometime.

For the time being in the ASDF, attention will first be given to the 2d Air

Wing which has many scrambles, with the intention of making the three F-15

squadrons 22-aircraft formations. However, the realization of the increase in

the authorized number will be in fiscal 1990 when the procurement portion for

this fiscal year will be acquired.

On the other hand, the 6 F-15DJ's procured in fiscal 19ö7 will be allocated to

renovation of the aircraft type for the Flight Training Squadron and spares.

The Flight Training Squadron currently has T-2's, but there are performance
limits for training operations with the T-2, and it is very significant that

this will be replaced with the F-15.

The deployment of the F-14DJ to the Flight Training Squadron also will be in

fiscal 1990.

It is not a new procurement, but one of the highlights of fiscal 1987 is the

mass renovation and transfer of F-4EJ aircraft with upgraded capability. The

plan to upgrade the capability of the F-4EJ was started with a trial

renovation in fiscal 1981 and up until the middle of fiscal 1985, a series of

technical and utility tests have been conducted. In September 1986, the

director of JDA gave approval for unit use. At that time, a decision was made

in conjunction to name it the "Improved F-4EJ."

After obtaining the approval of the Security Council in December 1986, a

request was made for renovation of 10 aircraft to the Improved F-4EJ in the

fiscal 1987 budget draft and 8 were approved in the budget. The ASDF

currently has the intention of making 9b of the 127 F-4EJ into the Improved F4EJ. These renovations will be implemented in consecutive year plans for a 7-

year period.

The remodeling to the Improved F-4EJ will be implemented along with scheduled

airframe maintenance (IRAN). Renovation costs in fiscal 1987 are 1.8 billion

yen per aircraft. Deployment of the eight aircraft requested this fiscal year

will be five to the 306th Squadron, two to the 1st Technical School for

teaching use, and one to the Air Proving Wing. Acquisition of the airframes

will be in fiscal 1989.

The T-4 Intermediate Trainer has the largest number of aircraft to be procured

in fiscal 1987. Twenty T-4's are to be procured in fiscal 1987. The volume

procurement of T-4 follows 12 aircraft in fiscal 1986 for an aggregate total

of 36 aircraft, including 4 XT-4.

Development work on the T-4 Intermediate Trainer will be completed at the end

of fiscal 1987 and next fiscal year, trial operation and operation tests will

begin in units directly under the Flying Training Command. Following

introduction of the T-4 unit, it first will replace the T-33A for teaching use

in basic flying courses. At this point in time, complete domestic manufacture

of trainers has been achieved from the T-3 to T-1 to T-4 to T-2.

On the other hand, the additional procurement of C-130H transports and CH-47J

transport helicopters is aimed at the improvement and strengthening of the air

transport system. Both the C-130H and the CH-47J aircraft procured this

fiscal year will be acquired in fiscal 1989- By this, a 12 C-130H aircraft

system will be established.

Similarly, the two CH-47J will be deployed to the Central Air Defense Force at

Iruma Air Base. This will complete deployment of aircraft to the Northern Air

Defense Force (three aircraft) and the Central Air Defense Force (four

aircraft). This CH-47J, as a terminal transport helicopter, will be in charge

of air transport of materials and personnel from the nearest base (airfield)

to detachments. It is called a terminal transport helicopter because it is in
Charge of the terminal portion of the transport route. It is scheduled to be

deployed to the three Air Defense Forces and the Southwestern Composite Air

Division.

So far, seven CH-47J aircraft have been procured, including the two aircraft

this fiscal year. Procurement is planned at present for five aircraft in

fiscal 1988 and thereafter for deployment to the remaining Western Air Defense

Force and Southwestern Composite Air Division.

Along with the deployment of the CH-47J, a reorganization of the Air Rescue

Wing will be conducted and as stated before, an "Emergency Irüma Helicopter

Transport Unit" will be formed in the middle of fiscal 1987. In a related

item to the Air Rescue Wing, selection of the aircraft type for the HH-X next

generation rescue helicopter has been postponed one year and additional

procurement of four V-107A will be conducted which should supplement this.

Procurement of the V-107A rescue helicopter will end with this fiscal year's

portion of four aircraft.

It had appeared that a decision in fact was made on the HH-bOJ for the

attention-getting next generation rescue helicopter, but this had a close

relationship with procurement of the MSDF SH-60J and the request this fiscal

year was delayed. Prospects are that the policy will be decided during fiscal

19ö7 and procurement will begin next fiscal year.

According to what has been reported so far, the HH-60J has 45 percent in

common with the SH-60J and it is equipped with a night vision device for

nighttime use.

Unit Operation, Other

There are no great actions in the aspect of unit reorganization, but the fifth

F-15 flight squadron will be born during fiscal 1987. This will end the

conversion of the 303d Flight Squadron at Komatsu Air Base from F-4EJ to F15J. The 303d Flight Squadron is the first unit to convert aircraft type from

the F-4 to the F-15. By this, the balance sheet occupied by F-4 and F-15 in

the 10 interceptor-fighter flight squadrons will be completely equal at the

end of fiscal 1907.

The organization of the sixth F-15 unit following the 303d Flight Squadron in

fiscal 1987 is scheduled for fiscal 1989 and will renovate the aircraft type

of the 304th Flight Squadron at Tsuiki Air Base.

Noteworthy in the aspect of instruction and training is the increase in annual

flight time for fighter pilots. The annual flight time for one fighter pilot

set by regulation is 200 hours. This standard was maintained until about

1970.

However, fighter pilot annual flight time quickly dropped to 140 hours

following the oil shock and that status has continued for a long time. It was

somewhat raised in fiscal 1980 and became 145-146 hours. This fiscal year, it

will be further increased 10 percent and be restored to 160.5 hours. The ASDF

has the intention of increasing it in the future to 180 hours, which is the
Standard of NATO air forces, and they hope to accomplish this in 10 years.

For the time being, a foothold has been established.

So far, the discussion has focused on fiscal 1987 aircraft procurement and

squadron operation items, but the modernization of other aspects, such as the

air defense units and control and warning units is proceeding steadily.

Similarly, the formation of base air defense units is proceeding and this

fiscal year, the 301st Base Air Defense Unit will be newly formed and

inaugurated at Komatsu Air Base directly under the Central Air Defense Force.

It can be said that the modernization of Air Self-Defense Force equipment in

various fields such as the F-15J, PATRIOT SAM, and the new BADGE [Base Air

Defense Ground Environment] system is progressing at a steady pace.

Maritime Self-Defense Force

In fiscal 1987, the Maritime Self-Defense Force will newly procure 35

aircraft. The breakdown of aircraft is 9 P-3C anti-submarine patrol aircraft,

17 HSS-2B anti-submarine helicopters, and 2 MH-53E minesweeping helicopters

(the above tactical aircraft) and in addition, 1 aircraft each of U-36A

training support aircraft, EP-3 electronic warfare data collection aircraft,

and LC-90 liaison aircraft, and 2 aircraft each of KM-2 Improved Trainers and

0H-6D helicopters.

The MSDF is currently heading toward a 100 P-3C aircraft system and provision

of the aircraft is proceeding aggressively. The aggregate total procurement

has reached 69 aircraft, including the 9 aircraft this fiscal year. There are

31 remaining aircraft in the calculation, but because there will be airframes

which will reach the 7,500 hours life expectancy and become decommissioned in

the meantime, the final procurement amount of P-3C»s probably will exceed 100

aircraft if this supplement is included.

Procurement of 17 HSS-2B anti-submarine helicopters was decided, but it will

end with this. Beginning in fiscal 1988, a switch will be made to full-scale

procurement of SH-60J new anti-submarine helicopters. The breakdown of the 17

aircraft is 9 for shipboard and 8 for land-based. This request was up to the

limit of the production capability of the manufacturer.

The number of MSDF land-based anti-submarine helicopters is markedly

inadequate and that is a strong reason why this volume procurement is covering

the portion that had been defeated up to the previous fiscal year. At any

rate, a stop has been put to the procurement of the HSS-2 system, which began

in 1963, at an aggregate total of 167 aircraft.

The procurement of the MH-53E minesweeping helicopter follows four aircraft

procured last fiscal year. In the Mid-term Defense Buildup Plan, 12 MH-53E

aircraft are to be introduced, a result of calculating the number required for

simultaneous operations at the two major port facilities, Tokyo Bay and from

the Kii Channel to Osaka Bay.

Deployment of the MH-53E will begin in fiscal 1989 and in fiscal 1990 there

will be a total of six aircraft, including the two aircraft to be procured
this fiscal year. The MH-53E, which has the combined function of a transport

helicopter, exists as what might be called "the anticipated new star" of the

MSDF, along with the P-3C.

The EP-3 electronic warfare data collection aircraft is in an airframe

category other than combat aircraft, but is considered a noteworthy new

procurement aircraft. This is a replacement for the one UP-2J that will be

decommissioned in fiscal 1990 and is an effort to upgrade both flight

performance and intelligence collection capability.

As a link in the upgrading of electronic warfare capability, which is

aggressively being taken up by the MSDF, the collection as well as analysis

and evaluation of daily radio information is an indispensable activity. For

that reason alone, the introduction of the EP-3 is to be enthusiastically

noted.

Similarly, the one U-36A training support aircraft to be procured is the

fourth aircraft in all to be budgeted. Two more aircraft will be procured in

the future and the U-36A will be employed as a six-aircraft system. The 81st

Flight Squadron at Iwakuni Air Base will be in charge of operating both this

U-36A and the aforementioned EP-3 electronic warfare data collection aircraft.

Fiscal 1987 Unit Reorganization

A large-scale reorganization of MSDF air units is scheduled for fiscal 19Ö7-

The largest of the series of unit reorganizations in fiscal 1987 is the new

formation of the 22d Air Wing. The newly formed 22d Air Wing will be

established at Omura Air Base in Nagasaki Prefecture. In addition to the

headquarters, it will be composed of the 122d and 123d Flight Squadrons, the

22d Support Service Squadron, and the Omura Air Base Squadron.

The birth of a new air wing in the MSDF is the first since the reorganization

of the Okinawa Flight Squadron into the 5th Air Wing in fiscal 1981.

In connection with this new formation of the 22d Air Wing, the 123d Flight

Squadron will be newly formed as the third shipborne helicopter unit. The

122d Flight Squadron will be reformed from the 21st Air Wing and similarly,

the 22d Support Service Squadron will be reorganized from the Omura Service

Unit. In the same fashion, the Omura Air Base Squadron will be reorganized,

expanding the organization from the Omura Base Unit.

Along with this reorganization, the Omura Air Squadron will become an A

formation unit of just a flight squadron and attendant service unit from the

existing B formation. Conversely to the present, the 22d Air Wing will

provide service support and base operations for the Omura Air Squadron. In

other words, the relationship of head and subordinate has been reversed.

On the other hand, the 21st Air Wing will transfer the 122d Flight Squadron to

the 22d Air Wing and the Komatsushima Air Squadron will be assigned under the

command of the Kure District. The existing irregular tri-site operation will

be eliminated and a streamlined formation will be made with the 101st and
121st Flight Squadrons and the 21st Support Service Squadron and Tateyama Air

Base Squadron under the headquarters.

Along with this reorganization, there will be realization of clear assignment

of duty with shipboard flight squadrons which are in charge of helicopter

onboard support for the DDH and HATSUYüKI DD under the Fleet Air Force and the

land-based anti-submarine helicopter units in charge of coastal defense under

the various regional districts.

Also of note in MSDF aviation in fiscal 1987 is the deployment of P-3C to the

Air Training Command. Along with this, there are changes in the crew training

system.

At present, the four Air Training Groups at Ozuki, Tokushima, Kanoya, and

Shimofusa are under the command of the Air Training Command. Each of these

units are in charge of training the pilot and airmen crew in stages. With the

fiscal 1987 reorganization, the Kanoya Air Training Group is abolished and the

new 206th Air Training Squadron will be inaugurated to be in charge of P-3C

crew training directly under the command of the Shimofusa Air Training Group.

This 206th Air Training Squadron is the unit in charge of centralized P-3C

crew training. The training of new personnel with the P-2J will end in the

middle of fiscal 1987. By this, the 203d Air Training Squadron currently in

charge of teaching the P-2J »Practical Aircraft VP Course," will be abolished

and this 203d Air Training Squadron will be the parent body for inaugurating

the new 7th Flight Squadron.

The newly organized 7th Flight Squadron will be placed directly under the

command of the 1st Air Wing at Kagoshima Air Base. As a result, the 1st Air

Wing will be the unit having the two VP flight squadrons. On the other hand,

the 211th Air Training Squadron in charge of helicopter crew training and

under the command of the Kanoya Air Training Group will become a unit under

the direct command of the Air Training Command and remain at Kanoya Air Base.

By this series of Air Training Command reorganizations, a radical change in

the crew training system has been realized. The newly organized 206th Air

Training Squadron is in charge of centralized training of P-3C personnel. The

205th Air Training Squadron under the command of the Shimofusa Air Training

Group will continue to exist and will be in charge of basic training of the

airman position category, including tacticians, as the stage prior to the P3C.

MSDF crew training now is welcoming an age of using the P-3C for education of

new personnel.

Ground Self-Defense Force

The Ground Self-Defense Force will procure a total of 32 aircraft in fiscal

1987. The breakdown is 8 AH-1S anti-tank helicopters, 12 0H-6D observation

helicopters, 8 HU-1H multi-purpose helicopters, and 4 CH-47J transport

helicopters. The procurement number for the three types of aircraft, the AH1S, 0H-6D, and CH-47J, is exactly the same as last fiscal year, but there are
8 HU-1H aircraft, an increase of 3 aircraft compared to the previous fiscal

year.

The major item for fiscal 1987 is cited as "the provision of AH-IS necessary

for the new organization of the 3d Anti-tank Helicopter Unit for improvement

of aerial mobility anti-tank firepower." Continuing from the previous fiscal

year, a budget of eight AH-1S was realized. At the end of fiscal 1986, a

total of 16 AH-13 aircraft were possessed and at the end of this fiscal year,

it will become 32 and in successive years until fiscal 1989, an increase of 8

aircraft per year is anticipated.

Four of the new CH-47J transport helicopters will be procured and the

aggregate total since fiscal 1984 is 13 aircraft. This CH-47J is the airframe

to replace the current V-107A. Replacement of the V-107A is being conducted

at a ratio of three to two and in the end, procurement of 39 aircraft is

scheduled.

The HÜ-1H multi-purpose helicopter is a replacement for the outdated HÜ-1B and

will be deployed to the helicopter units of each Army. On the other hand, the

0H-6D observation helicopter will be deployed to various division squadrons in

addition to use for reconnaissance in anti-tank helicopter units. The

airframes for the division squadrons are replacements for the 0H-6J.

Trends in Fiscal 1987

Noteworthy in the actions such as unit reorganization is the new formation of

the 2d Anti-tank Helicopter Unit, the second AH-1S unit. This 2d Anti-tank

Helicopter Unit will be formed at Camp Hachinohe in Aomori Prefecture.

Deployment of anti-tank helicopter units is proceeding from the north, founded

on the basic strategy of "northern emphasis." The 1st Anti-tank Helicopter

Unit was newly formed and inaugurated at Camp Obihiro in Hokkaido at the end

of fiscal 1985. At the outset, the number of aircraft was not complete and it

was formed for the time being with half the number, but formation was

completed during fiscal Iy86.

The authorized number for formation of an anti-tank helicopter unit is 16 AH1S's, 4 0H-6J's and about 200 men. In addition to the unit headquarters, it

is composed of a unit attached to headquarters and a flight squadron.

The 2d Anti-tank Helicopter Unit was born in fiscal 1987 as the second of

these units. For the time being, it will start this fiscal year with a half

formation and formation will be completed over a 2-year period. Thereafter,

an anti-tank helicopter unit will be formed in 2 years with a base of one

unit. Tne third AH unit will be newly formed and inaugurated under the

command of the Middle Army in fiscal 1989.

In the Mid-term Defense Buildup Plan, the GSDF has scheduled the procurement

of 43 AH-1S aircraft. They would like to form 4 and 1/2 anti-tank helicopter

units with a total of 73 aircraft, including the 30 aircraft procurement

portion up to the 1984 Mid-term Operations Plan. The GSDF now is off to a new

start in the area of "air combat."
Another focus of GSDF aviation is the CH-47J transport helicopter. Two

aircraft have been acquired up to the end of fiscal 1986 and training of

skeleton personnel will begin soon in the new fiscal year at the Akeno

Aviation School.

The acquisition of an additional three aircraft was scheduled by the end of

fiscal 1987, but only one aircraft will be deployed to the 1st Helicopter

Brigade. This CH-47J has a fully equipped weight about 2.3 times (50,000

pounds), an engine output about 2.5 times (7,500 horsepower), and maximum

speed of about 1.2 times (160 knots) compared to that of the V-107A.

Transport capability is 55 men (V-107A is 26 men), and it has a strong

airframe markedly superior to the V-107«

The GSDF, MSDF, and ASDF are now greeting a great period of change in the

aircraft they are furnished. It can be said that steady development is being

accomplished respectively, embracing a noteworthy main theme. Taken from a

wide viewpoint, it is forecast that fiscal 1987 will be an important year to

be described as epoch making in all sorts of ways in self-defense force

aviation.

12256

CSO: 4105//09Ö
MILITARY

REORGANIZATION OF GROUND SELF DEFENSE FORCE DIVISIONS SEEN

Tokyo GUNJI KENKYU in Japanese May 87 pp 24-31

[Article by Military Analyst Tetsuo Kawamoto]

[Excerpts] First Division Reorganization In 26 Years

A division modernization project was approved in the fiscal 1987 budget draft

with measures to improve and modernize ground fighting power as one of the

main underpinnings. This fiscal year, the 2nd Division and 7th Division are

being modernized. There was a small-scale "scrap and build" reorganization in

fiscal 1980, with the 7th Division made into an armored division, the 8th

Division restructured into an A Division (9,000-men division, 4 infantry

regiments), the 3rd Division restructured into a B Division (7,000-men

division, 3 infantry regiments), and the new organization of the 2d Combined

Brigade. However, there has been no overall restructuring of divisions since

the division reorganization of fiscal 1961.

The structure of divisions, which are the strategic unit, has inevitably

changed along with modernization of equipment and changes in tactical

concepts.

It is somewhat strange that the Ground Self Defense Forces has had the same

division structure for close to 30 years. The current division structure was

the result of using the pentamic form as a model, sweeping away all the

numerous logistic units, and forcing the 6 regional units and 4 combined

brigades into 13 divisions. As a result, there has been much dissatisfaction

that "fighting was impossible" since the outset of the division

reorganization. Thirteen divisions have had to be maintained within the

limit of 180,000 men. Moreover, with the new organization of the 1st

Combined Brigade accompanying the return of Okinawa and the establishment of

the 2nd Combined Brigade for the forlorn Shikoku, modernization of the

division had not begun at all.

Changes in tactical concepts and the fighting conditions of an anticipated

future war are completely unknown to outsiders, but some people are keeping

tabs on equipment modernization. The division artillery regiments of the

Northern Army all are uniform with 155mm self-propelled howitzers. Regiments

such as the 2nd Artillery Regiment can be called a lineup that is first-rank

10
in the world for division artillery with 11 companies, 12 130mm twin-mounted

rockets on 55 guns, if they have enough ammunition. The brand new FH70 is

being introduced even in the interior division artillery regiments. They

have not just howitzers, but superior equipment not even imagined 30 years

ago, such as domestically manufactured tanks and anti-tank missiles.

The modernization of division structure is necessary just from this

modernization of equipment alone. Also, since the Ground Self Defense Force

180,000 men limit has remained set, a rather drastic shift in emphasis is

required. At the same time holes will be created somewhere and problems will

occur in how to cover them. Thus, in the Mid-term Defense Buildup Plan that

was decided in September 1985, modernization and diverse organization of

divisions were proposed with upgrading of capability to deal with landings as

the main underpinning.

The modernization project for the 2nd Division and 7th Division that was

approved in the budget draft this fiscal year is an epoch which will be the

foothold for a continued series of division modernizations under this Mid-term

Defense Buildup Plan. Modernization of the 5th Division and 11th Division are

scheduled for next fiscal year, completing the modernization of the four

divisions in the Northern Army. Modernization of the interior divisions will

be in 1989 and thereafter.

Modernization of the 2nd Division

A Front-line Division

The 2nd Division, in charge of the northern part of Hokkaido, has the oldest

history among the four Northern Army divisions, as the division number

indicates.

North Hokkaido is closest to Sakhalin, probably the base of Soviet operations.

The Soya Straits, one of the three sea straits, also is within the 2nd

Division district. Consequently, it is thought that the 2nd Division will

be first to face attack, whether by limited occupation of the shoulders of the

strait in order to push through the three straits or by a hole-punching attack

planned for occupying the whole region of Hokkaido. Therefore, new equipment

is sent on a priority basis to the 2nd Division and the adequacy rate also is

handled specially. Also, this division modernization has started with the 2nd

Division.

Currently, the 2nd Division has its division headquarters in Asahigawa, and as

its nucleus the 3rd, 9th, 25th, and 26th Infantry Regiments, the 2nd Artillery

Regiment, and 2nd Tank Battalion. In its district there are five camps:

Asahigawa (Division Headquarters, 9th Infantry Regiment, and 2nd Artillery

Regiment main force, 2nd Engineer Battalion, 2nd Communications Battalion),

Nayoro (3rd Infantry Regiment, 2nd Artillery Regiment - 2 battalions, 2nd

Reconnaissance Unit, 4th Anti-aircraft Artillery Group, 301st District Engineer

Unit), Rumoi (26th Infantry Regiment), Engaru (25th Infantry Regiment), and

Kami Furano (2nd Tank Battalion, 2nd Anti-tank Unit, 4th Artillery Group, and

308th District Engineer Unit) and four detachments: Chikafumidai (Fuel Depot,

Ammunition Depot), Wakkanai (301st Coastal Patrol Unit), Tada (Ammunition

11
Depot), and Rebun (301st Coastal Patrol Unit Detachment). The 4th Antiaircraft Artillery Group and the 4th Artillery Group are not under the command

of the 2nd Division; they are under the direct command of the Northern Army

but in fact, are units supporting the 2nd Division.

Motorizing and Armoring

The motorization and armoring of infantry regiments are at the heart of the

division modernization project. In the budget this fiscal year, three

regiments, the 9th Infantry Regiment of Asahigawa, the 25th Infantry Regiment

of Engaru, and the 26th Infantry Regiment of Rumoi, will be motorized, and the

3rd Infantry Regiment of Nayoro will be armored. To withstand the first

attack, the armoring of Nayoro at the center and northern-most tip to defend

National Highway No. 40 which is the major approach route, and the motorizing

of Engaru on the left flank, Rumoi on the right flank, and Asahigawa in

reserve is an appropriate disposition. The armoring of Asahigawa would be

desirable also, but so far they have not be able to attend to it. However,

if the impression that there is one more regiment to armor is not left, there

is a great possibility that it will become outdated in another 10 years.

In the specifics of motorizing, it is a great mistake to call to mind the

motorized sniper divisions of the Soviet Union. In short, it is a posture in

which 10 large trucks are added to each regiment and the regiment obtains

mobility with independent vehicles. The specifics of armoring are to have 62

armored personnel carriers (APC) centering on the 73 Model APC as intrinsic

equipment of a regiment and the main power of the regiment would be its

mobility capability with APC. If the mechanized infantry combat vehicle

(MICV) currently under development is perfected, it will be scheduled to

replace the APC gradually.

From a world view, it has been a general trend to go from infantry APC to

MECV. The Ground Self Defense Force in contrast has made only two regiments

APC, the 11th Infantry Regiment of the 7th Division and a regiment which

receives the support of the 101st armored transport unit. The other 44

regiments are not even motorized. One regiment among the four regiments of an

A Division barely can have vehicle mobility with the support of division

transport units. The other three regiments have motorized heavy trench mortar

companies, recoilless gun platoons within a regiment company, and trench

mortar platoons. The main force rifle platoons only have their own feet as a

method of mobility.

It is a fact that tanks are the nucleus of a land war. That tendency is

particularly strong in Hokkaido, but infantry accompaniment is indispensable

for it to demonstrate fully its power. For that reason, in various nations

at least one armored vehicle is produced and outfitted for every tank. In

Japan, there is an armored vehicle for every five tanks. Procurement of the

main force 73 Model APC began in fiscal 1973 and so far 180 have been

produced. During hard times, only six vehicles were authorized for four

consecutive years. The price for a 73 Model APC in contracts this fiscal year

is 120 million yen each. It is not much of a comparison, but one M113 APC is

about 38 million yen. In short, it is too expensive and therefore the number

has been limited. Also, it has slid into the vicious circle that because of

12
small quantity, it has become expensive. In order to break this vicious

circle, one method probably would be the development of an APC cheaper in

price and not requiring maintenance costs, even if performance is somewhat

lowered. It is not known whether or not the Model 73 APC is the crowning APC

in the world, but there is no dispute in the point of luxuriousness. Since

war ultimately is a number of victories or defeats, this probably will become

a serious issue in the case of the new MICV.

Strengthening of Tank Battalions

A plan was proposed in the Mid-term Defense Buildup Plan that one tank company

would be taken away from tank battalions of the 6th Division and those further

south, and these would be held in the Northern Army. Attention was drawn to

what form the tank units of the Northern Army would take. That shape became

clear with the addition of the 2nd Tank Battalion that was approved in the

budget draft this fiscal year.

Tank battalions of A divisions up to now have consisted of a main company

equipped with 4 tanks and four tank companies equipped with 14 tanks for a

total of 60 tanks. A tank company has the company headquarters equipped with

2 tanks and three tank platoons equipped with 4 tanks. With this addition,

there will be four platoons in these tank companies. It not known what

operational formation they will take but from the numbers, a tank platoon

could be assigned to each of the four infantry companies if one tank company

is assigned to each infantry regiment to form a combat group.

By simple calculation, the authorized number of tanks in a strengthened tank

battalion becomes 76, but it will be 74 since the main company has 2 tanks.

It probably will be the largest tank battalion in the world and it will have

the same number of tanks as the tank regiment of the 7th Division. There is

some unease about whether a battalion commander can command 74 tanks, but tank

group operations like those of the 7th Division which specialize in mobile

attacks are not considered. Since the operation is different and the degree

of completeness of support systems such as servicing is different, it has not

be raised to regiment status as stated by some and the title of 2nd Tank

Battalion follows suit as is.

In the plan, 140 tanks will be brought into the Northern Army from the 6th

Division and those farther south. With these 140 tanks, there will be 100

tanks remaining if the 2nd Tank Battalion is added this fiscal year and the

5th Tank Battalion and 11th Tank Battalion next fiscal year. These will be

allocated to the addition of the 1st Tank Group.

Independence of Anti-aircraft Battalion

The lack of battlefield air defense capability commonly is pointed out.

Except for the 7th Division, air defense of divisions up to now has been

assigned to the 6th Battalion of the artillery regiment, but those ranks have

been meager. Equipment consists of 8 sets of 35mm L-90 machineguns and 12

self-propelled anti-aircraft machineguns, but no division exists with these

complete. The I/-90 is an effective weapon against position air defense, but

the art of air defense accompanying a unit is difficult. The self-propelled

\

\
anti-aircraft machineguns have a good reputation, but the M-15 which is a

mixed loading of a 37mm gun and 12.7mm machinegun on an M-3 halftrack belongs

to the World War II era. There is also the twin-mounted 40mm gun M-42, but

this also is a period piece and there are only 8 of them.

This sad situation is probably the result of money and personnel being eaten

up by HAWK units. Recently, the procurement of the 81 Model short-range SAM

also has gotten on track and moreover, this fiscal year AWX will appear. It

can be said that the role of battlefield air defense finally has been

completed by these. To respond to this action, as a policy of division

modernization, the 6th Battalion of the 2nd Artillery Regiment will become

independent and form the 2nd Anti-aircraft Battalion under direct division

command.

The future form of the anti-aircraft battalion probably will be an AWX company

combining 2 sets of 81 Model short-range SAM (1 set consists of 1 firing

control device, 2 four-mounted launchers, and 16 missiles) and several

regiment combat groups. The price of AWX is very high, however. The first

procurement this fiscal year will be 6.5 billion yen for four. There is great

doubt that the number will be completed with this.

New Organization of Chemical Protection and Electronic Surveillance Platoons

As another modernization policy, a chemical protection platoon will be newly

formed within units attached to division headquarters. The Soviet forces have

chemical protection battalions in divisions and companies in regiments. U.S.

military divisions also have NBC companies for the most part. Various nations

seriously view NBC protection in this way but in the Ground Self Defense Force

up to now there has only been one unit, the 101st Chemical Protection Unit.

There are no units in charge of this field either in the armies or in the

divisions. However, each person carries a gas mask and there is NBC

protection gear in only a very few armored vehicles.

Although on a small scale, the new formation of a chemical protection unit

within a division is a big advance. If chemical departments were to be

restored in army headquarters, it would have a good effect on increasing

concern for NBC protection. At any rate, since it is a platoon within an

attached unit, large scale contamination removal cannot be done. They will

probably be in charge of grasping the contamination situation with one or two

vehicles, marking off the contamination zone, and conducting chemical

protection instruction and support for each unit.

As another modernization policy, an electronic surveillance platoon will be

newly formed into the 2nd Reconnaissance Unit. Details are unknown but it is

thought to be a unit that will intercept and detect enemy radio communications

and anti-gun and anti-mortar radar activity, range those positions, and

investigate troop strength and organization. In the future, it probably also

will be charged with the duty of aggressively jamming enemy electronic

activity. This will give it a new capability that has not existed in

reconnaissance units up to now.

14
New Formation of Logistics Support Regiments

None of the policies mentioned above brings an increase in personnel. So,

somewhere there must be rationalization and a decrease in personnel. Also,

along with plans for smoothing logistics support, the 2nd Logistics Support

Regiment will be newly formed, combining a weapons unit, supply unit,

transport unit, and medical unit. This measure also was conducted when the

7th Division was armored, but it became a weapons battalion because the 7th

Division was equipped with over 700 track-type vehicles and there were many

servicing requirements. In the case of the 2nd Division, it will be kept to a

weapons unit since there are not that many servicing requirements.

The decrease in personnel made possible by this rationalization offsets the

personnel increases of the other modernization policies, holding it to an

overall increase of 90 men. It should be highly praised as the result of

tearful effort. However, since logistics support and the divisions overall

had no depth even without this, it probably would not be wise to compress

the numerous logistics units any further. Whatever the case, ultimately there

are great problems in the point that it is only possible by scrap and build.

The bottleneck is the limit of 180,000 men. To modernize, they must be

resigned to a corresponding increase in personnel and secure it.

Modernization of 7th Division

Mobile operation units were determined in the Outline of the Defense Plan and

the 7th Division, the pride and joy of the Northern Army, reached the level of

world power divisions with armoring and reorganization in fiscal 1980. Its

ranks of 232 tanks, 336 APC, and 40 155mm self-propelled guns, scraped

together by concentrating all their effort, is quite a thing. Consequently,

in the division modernization this year there will be no more than partial

readjustment and additions through introduction of new equipment.

First, a chemical protection platoon will be newly formed within units

assigned to division headquarters, as with the 2nd Division.

A new roadblock operations vehicle will be introduced as new equipment in the

7th Engineering Battalion, and it appears that its structure also will be

partially readjusted. This roadblock operations vehicle is a remodeled large

truck which can use six kinds of attachments. It is engineering equipment

which can swiftly construct barriers on paved roads.

Radio carrier-frequency terminal equipment No. 2 will be added to the 7th

Communications Battalion to deal with the increase in communications volume.

Eight reconnaissance patrol vehicles will be introduced as new equipment in

the 7th Reconnaissance Unit. With these it will have a posture in which it

can demonstrate the character of armored reconnaissance in which full power

reconnaissance is possible.

15
X 1

X 3

tanks X 74

Summary of New Division

As stated before, division modernization is scheduled for the 5th Division and

11th Division next fiscal year and for the 6th Division and those further

south after that. The details of what they will be like are indicated in the

Mid-term Defense Buildup Plan. Viewed collectively again, it is as follows:

Northern Army 9,000-men Division

armored infantry regiment

motorized infantry regiments

tank battalion (platoon x 16),

anti-tank unit, 79 Model Heavy MAT x 16 sets

The inherent anti-tank capability of these infantry regiments will be

strengthened. For the present, half of the 106mm recoilless guns with which

infantry companies are currently equipped will be replaced with the new medium

MAT. The first procurement of medium MAT this fiscal year will be for two

divisions.

If the example of the 2nd Division is applied to the 11th Division, it will be

as follows: the armoring of 10th Infantry Regiment at Takikawa, motorizing of

the 18th Infantry Regiment at Makomanai, 28th Infantry Regiment at Hakodate,

and 29th Infantry Regiment at Kutchan seems natural.

Since the frontal area charged to the 5th Division is wide and on the east

side of Hokkaido where the operation of large armored units is easy, it was

thought that the current 7,000-men B division possibly would be raised to a

9,000-men division, but it appears it will remain as a B Division. This

7,000-men division in the Northern Army consists of 1 armored infantry

regiment, 2 motorized infantry regiments, a tank battalion with 12 platoons

and 56 tanks, and an anti-tank unit with 12 sets of 79 Model Heavy MAT. It is

difficult to guess which of the 5th Division infantry regiments will be

armored. It appears that the 6th Infantry Regiment at Bihoro will be armored,

but there are also views that it will be the 27th Infantry Regiment at Jushiro

because of its relationship to the maneuver grounds, or the standard-bearer

4th Infantry Regiment at Obihiro. Which of these it is to be will become

clear next fiscal year.

The 9th Division at Aomori is a 7,000-men division like those at present, and

the 6th Division and those further south 9,000-men divisions consist of the

following:

motorized regiments x 4

tank battalion (company x 3), tanks x 44

anti-tank unit, 79 Model Heavy MAT x 16 sets, Medium MAT x 16 sets.

12256

CSO: 4105/097

16
ECONOMIC

NEW JAPANESE AMADA PLANT IN FRANCE, TECHNICAL CENTER IN FRG

Amada Technical Center ,

Duesseldorf HANDELSBLATT in German 25 May 87 p 1

[Article by "ga": "Nearer to the Customers"]

[Text] Tokyo, 23/21 May—The Amada Company, theleading Japanese manufacturer

of metal-working machinery, is placing its hopes in a division of operations

within this group on an international scale so as to make it unnecessary to

expand' further its exports from Japan. As'company head Mitsuaki Amada

explained to the HANDELSBLATT, within the framework of this concept even the

delivery of machinery from the production centers in foreign countries to

Japan should then be possible.

This year, the dominant focus of its commitment in Europe is the commencement

of production of punch presses in France. The entire European market is to be

supplied from this site. For the time being a production outfit in Germany is

not being considered. Instead, the sales center in the FRG is to be expanded

into a technical center.

Punch-press Production in France ;

Duesseldorf HANDELSBLATT in,. German 25 May 87 p' '13 "! _.-..-"/'

[Article by Andreas Gandow: "New Punch Press Production in France"]

[Text] "This year, the commencement of production of punch machines in France

is the focus cf our commitment in Europe," declares Mitsuaki Amada, president

of.', the Amada Company, the leading Japanese manufacturer of metal processing

machinery. Back in in the 1970's this company began on the establishment of a

worldwide network of centers for sales, production, and development. In

Germany, the sales center is to be expanded into a technical center.

In 1951, Mitsuaki Amada (born in 1932) joined ,as a 19-year-old the company

that was founded by his brother Isamu after the end of the war. The original

business of this company was the repairing of machinery. Amada has been a

member of the management since 1965, and since 1953 he has headed the group of

firms as the chief executive (president).

17
In the mid-1950's the company then itself undertook the production of band saw

machinery and metal working machinery. Moreover Amada developed an

independent organizational and marketing philosophy, which allowed for the

first time the expansion of the company and made the group as a whole into the

leading manufacturer of metal processing machinery in Japan.

For this company, fiscal year 1986/87 (31 March) was marked by a distinct

worsening in sales and profits, because of the extreme upward evaluation of

the yen and investment weakness in important customer sectors such as the

automobile and electrical industry. While sales declined by just under 17

percent to 97.2 billion yen (about DM 1.2 billion), and export proceeds

declined by H percent to 20.2 billion yen (about DM 250 million), there was a

halving of the ordinary earnings (profit before extraordinary returns and

taxes) to merely 7.9 billion yen (about DM 95 million). Just in the previous

fiscal year a decline in earnings of just under 20 percent had to be absorbed.

However, in this connection Mitsuaki Amada points to the important

contribution made by the division of sheet-metal working machinery, where the

decline in sales of only just under 10 percent was below average, since the

company is profiting from the healthy demand in domestic building

construction; in exports it even proved possible to achieve a definite plus

amounting to a good 7 percent.

A distinguishing feature of the organization of the group, which now includes

20 Japanese and 17 non-Japanese firms, is its operating in separate productspecific and function-specific business units: The production and selling of

the various machines and systems as well as the computers for controlling the

manufacturing process and the programs required for these are located in

independent firms each time. This applies also to the production firms of

Sonoike and Wasino.

However, the Amada Company Ltd in Ishida that functions as the holding

company of the Amada group is centrally responsible for the overall research

and development activities. Thus, under its direct control is the Central

Research Institute and the Material Research Institute of the group, in which

working teams composed of employees from individual group firms are always

formed for separate projects having fixed deadlines.

Mitsuaki Amada mentions three reasons for this organizational structure: ^ On

the one hand, it has beer; possible to adapt the working conditions and salary

structures in the separate units flexibly to the respective requirements^.

Moreover, the decentralized organization permits a more flexible giving of

attention to market developments. But finally, the creation of separate but

also interrelating firms leads to a business awareness in the respective

management that would not be brought about if it. merely functioned as a

factory management in a large enterprise. This structure has proved its worth

especially in the implementation of rationalization projects, Amada

emphasizes.

18
Consultation, Material Testing Runs

Central to the marketing conception of the group is the so-called "Amada

Industrial Machinery Plaza," as a forum for dialogue with customers and

interested parties. On an exhibition area of Just under 10,000 square meters,

which is open 3 days out of the week including Saturday, about 200 different

types of machinery of the group firms are presented. Here, interested parties

can "be given advice and at the same time can carry out test runs with their

own material in order to determine, in talking with technicians of the

company, the set of machines or the system suitable for their needs, inclusive

of the requisite control units and programs. Therefore Amada views the plaza

not merely as a sales site but also as a front line of the development

activities of the group, with institutionalized feedback to product

development. Finally, this center is complemented by its own education and

training facility for technicians of the customer firms.

Moreover, in addition to a sales organization the company has established its

own production facilities in the United States and Europe. In the united

States, numerically controlled turret presses inclusive of the tools required

for these are being manufactured, as well as laser cutting machines. In

Europe, the Amada U.K., Ltd. is the location for the production of tools for

CNC turret punch presses and the Amada Italia S.r.L. is the location for the

production of bands for band-saw machines.

Moreover, in June the production of numerically controlled punch presses for

the entire European market is to now begin at the Amada Works in France.

Mitsuaki Amada stresses on this point that this will be a purely European

production that will take the place of exports from Japan, since also the

components and the control units will be obtained from other production

centers of the group in Austria and Italy. To this end, the Japanese company

had completely taken over the firm of Promecam Sisson Lehman S.A. (now: Amada

S.A.) at the end of last year.

According to Mitsuaki Amada, the sales center in the FE3 at the Amada GmbH,

Haan, is to gradually be expanded into a technical center, in which potential

customers can have tests run and where the requisite training for the future

technical personnel of the customers can be carried out. But Amada declares

that a production site in the FRG is not under consideration at present.

These activities are being supported by centers for research and development

work'in America and Europe: In the United States, since the beginning of the

1980's at the Amada Engineering & Service Co., Inc., and in Europe since 1985

at the Prima Industrie S.p.A., in which the Japanese company holds a share of

49 percent. Initial results of this Japanese-Italian cooperation are on hand,

and it has already proved possible tc integrate these results into systems of

the company, declares Mitsuaki Amada.

Division of Operations Instead of Exports

In addition to this direct international commitment, there is technical and

sales-related cooperation with Brown & Sharpe Mfg. Co. (United States) in

connection With surface grinding machines, with Digital Electronic Automation

19
(Italy) in three-dimensional mensuration engineering, and with Charmilles

Technologies S.A. (Switzerland) in electronic discharging machines.

This international division of labor within the group is to be expanded in the

future, so that thereupon even the delivery of machines from the foreign

production centers to Japan will be possible: "A further expansion of exports

from Japan is not our aim," stresses Amada.

But the forecast of the company is that the decline in sales of the two

previous years will continue also in the current fiscal year of 1987/88. At

the end of March, the order backlog of 12.4 billion yen was a good 13 percent

below the corresponding value of the preceding year. For the entire fiscal

year the company is now anticipating another sales decline amounting to a good

3 percent, to 94 billion yen.

However, the ordinary earnings should show improvement again by about 10

percent, to a figure of 8.7 billion yens, due to a closer organizational

association between the divisions of sales and development. To ithis?end,

declares Mitsuaki Amada, at the beginning of this month five business units

were formed that are endowed with greater powers for the product lines of

band-saw machinery, sheet-metal working machines, sheet-metal working systems,

presses, and plastics processing machinery, in which a close intermeshing of

the design engineers in the sales activity is to be done for the purposes of

strengthening the company's market position.

12114

CSO: 3698/468

20
ECONOMIC

STUDY ON DYNAMICS OF FOREIGN EXCHANGE RATES

Tokyo THE JAPAN TIMES in English 29 Jul 87 pp 7-9

(Article by Kenichi Ohmae]

[Text]

^Exhibit/!

PURCHASING POWER

V/S;1986 '.-.

CTV

'Coke

Electricity

Beer

Eggs

Movies

Housing

Hamburger

Coffee

Refrigerator

Taxi

Gasoline

Beef

1 181

I

197

~] 19B

~~T220

_J 233

| 250

| 260

300

1 320

I 335

~\ 346

i

140

Since Japan liberalized its

foreign exchange (FX) laws

in 1980, the yen has joined the^

Western basket of currency

trading. What this means is

that about two-thirds of the

world's economy is now

rather freely interlinked

through currency trading.

Traditional

economic policies based on a

closed-country

model, such as

Keynesians

and the monetarists, are

460

Zl 594

being seriously challenged.

For example, the existing

models cannot explain simple

and now not-so-uncommon

phenomena, such as these:

• Employment is created in

a Korea when the American

economy picks up.

• Money appears in the

U.S. overnight when the Japanese money supply is too

much.

• Economy recovers while

unemployment goes up. due

to robots taking over human

jobs.

, • Currency fluctuates more

than 40 percent a year when

the fundamentals of the two

economies — Japan and the

U.S. — really haven't

changed much.

We are trying to develop a

model to explain the globally

interlinked economy. At this

stage, we think we have an

interesting model for the currency portion of the interlinked economy, which merits critical appraisal from scholars

and students of currency trading. Let me describe our basic

understanding of the current

situation, the assumptions in

constructing our model, and

the results of our initial

testing.

Basic understanding of

foreign exchange

A survey conducted by central banks at the end of March

1986 indicates that the trading

volume of FX in the three key

markets of London, New York

and Tokyo was in the order of

$200 billion a day. London was

the largest of the three at $90

billion, followed by N.Y. at

$50-58 and Tokyo at $48-50

billion.

Foreign exchange trading,

along with futures and options, was designed to assist

in smoothing international

transactions such as trade

21
^Exhibit 2 A

PRICE INDEX

May 1985- 100

Japan

110

West Germany

100

90

80

70

oo

::a-^

50

110

Consumer 100

SO

Wholesale

Import

Si**» ^ I.... C

^>.^ - w

K—I

1985 19B6 1987

50

1985 1986 1987

H Exhibit 3

MONTHLY RATE OF CHANGE — YEN VS. DOLLAR

Highest minus lowest price in a month as percent of the monthly average

I

&

US

St-iSi

u.103 M idUmlull iliiriiaisiif::!;-. ipMmw ,

--VI-II fc|l Jv»« tS^-HW.TiSWiW

foil

IKK

, .,_.JII*I:J .

Ill 11

m j£' —

.i?.s.«rvi-'«;'.!5äi*yA

arji-cUatttfi!??.-!.'^:?.;.-;

79.1 80.1 81.1 82.1 83.1 84.1 85.1 85.12

and investment. Such activities amount, at the most, to

only about $20 billion daily

amongst the U.S., Europe and

Japan. It cannot possibly explain the current size of the

FX market, which is 10 times

larger than the volume of

"real" transactions. What

has happened is that the FX

market has started to have its

own raison d'etre, and has developed unique behavioral

patterns that must be treated

with care and interpreted

with a new perspective. For

example, the FX market has

been proven to:

• Üwarf government intervention. Against the declining

dollar, the Bank of Japan

(BOJ) had injected some $16

billion to arrest the dollar's

free fall from March 19, 1986

through Jan. 29, 1987. During

the two-and-a-half weeks at

the beginning of this year,

BOJ injected as much as $8.5

billion to support the dollar, to

no avail. The FX market has

become an empire of its own,

or the Third Empire, which

seems completely independent of the Group of Five or,

for that matter, any government.

• Not reflect "purchasing

power." As Exhibit 1 indicates, there is no major item

which can justify the current

exchange rate of Y140 to the

dollar. In fact, a more reasonable conversion rate is certainly above Y180, in order to

equalize the prices of day-today commodities.

There are several reasons

for this seemingly perplexing

issue. One, and the most obvious, is that the Japanese

distribution system is much

more extended and less efficient than that of the U.S. So,

a Japanese-made camera can

be purchased at a much lower

price at the 47th Street Photo

Shop in New York City than at

Yodobashi Camera, a Tokyo

discount store. A typical

camera or color-TV is priced

at four times its manufacturing cost. So, "purchasing

power," which was believed

to influence the currency exchange rate in equalizing

prices, needs to be redefined

using a product's cost to the

importing decision maker.

International trade occurs

based on the competitiveness

of a product's delivered cost

(i.e., manufacturing plus

logistics cost), as opposed to

sales price. In order for Japan

to increase imports, as the

dollar and other currencies

gain relative advantage, distribution must be streamlined. The so-called price

elasticity due to exchange

rate change does not happen

if the lower or higher price is

not passed on to the real purchasing decision maker. For

example, if an American scientific instrument's delivered

price is lowered as a result of

a weaker dollar, it may gain a

share of the market from its

Japanese competitors, and

the American export may

climb up, showing clear signs

22
of elasticity. Likewise, if cotton oil became more competitive than sesame seeds and or

coconut oil, the U.S.-made

cotton oil might displace

other types of oil as sources,

e.g., for making salad oil. So,

while the end user price may

not go down, as the middleman "pockets" the additional

profit, elasticity is observed

as the exchange rate changes.

However, in most cases, a

simple reduction in the import price at the cost-insurance-and-freight (CIF) or

free-onboard (FOB) levels

does not result in increased

imports, as little is passed on

to the consumers. Indeed,

consumers of both West Germany and Japan have not

really benefited from the decrease in import prices as

their currencies have

strengthened, as shown in Exhibit 2. Thus, Japanese imports have not increased, despite the stronger yen.

• Yield much better performance than other financial

instruments available in the

real world. Exhibit 3 shows

the monthly dollar/yen exchange rate fluctuation over

the recent nine years. In all

but two months over nine

years, the FX market has

fluctuated more than one percent in a month. In fact, the

average move has been 4.5

percent per month, or 55 percent per year for a consistent

winner in the FX market.

Quite often, opportunities to

make more than 6 percent per

month appear (Exhibit 4).

Similar high yield opportunities may exist in real estate,

stocks, gold and, in the case of

Japan, golf-club memberships. However, such capital

gains are usually taxed to

effectively halve the yield;

but the FX market is unlimited and unregulated in size,

frequency of exchange, gains/

losses and taxes.

The FX market is

unlimited and

unregulated in

size, gains/losses

and taxes

What this means is that the

FX market has become one of

the largest investment instruments in itself, and is interchangeable with other instruments. At the root of this

problem is the worldwide superliquidity problem. In

Japan alone, some $1.1 billion

is generated daily from the

private and corporate sectors

to be invested. Since there are

not many opportunities to

substantively absorb such an

amount of money in real consumption, the excess money

ends up in the available instruments, or "buckets." For

institutional investors, it does

not make any difference in

which buckets the money is

put, so long as they are interchangeable and tradeable.

Tokyo's stock market has

already absorbed as much

water (i.e., money) as any

logical mind can imagine, at a

PER of 80. The real estate

bucket also has been filled

high, as real-estate prices in

central Tokyo have risen

three to five times in the last

three years. It does not mean

that the utility of real estate

has grown threefold. It simply

means that it has absorbed as

much money as it can. The

payback period of an average

office building is now over 100

years, such a phenomenon

can only be understood with

the expectation of continuing

inflation in selected realestate properties. The $2-million membership fee for the

Kasumigaseki Country Club

is also reconcileable only

when one discovers that these

golf-club memberships are

traded in Tokvo. Even in

Japan, the price of untradeable properties, such as real

estate in remote and rural

locations, is going down, indicating that tradeability is the

key prerequisite for qualifying as a bucket for cash

overflow.

This new phenomenon suggests that several major

changes are taking place,

which would challenge the

traditional understanding of

economics.

Measuring inflation

(1) The traditional measure

of inflation, the use of consumer and wholesale price indices (CPI and WPI), is obsolete. Until recently, overliquidity resulted in inflation,

as a result of excess money

buying up inventory in expectation of higher prices. Today,

in an era of worldwide oversupply, excess money is contained in tradeable buckets,

and has not harmed the greater public by increasing inflation. This is because higher

prices are certain to discourage demand. When supply is

tightened, there is always a

high probability of inflation.

We are living with a zebralike inflation today, where

CPI and WPI are stable, but

real estate and stock prices

are sky high. In a way, the

creation and discovery of

these liquidity buckets, and

the successful containment of

excess money therein, have

been the key ingredients in

curbing inflation. Governments cannot be credited

much with this success. Their

sugar-coated monetary policies would have created unmanageable inflation across

the board, were it not for the

invention of the globally interlinked buckets and the occasional "leaky" buckets which

act as "black holes" (Exhibit

5).

(2) The worlds money supply has gone beyond the control of any single government.

Through interlinkage and the

23
£EKHIbltv4#

DISTRIBUTION OF MONTHLY FLUCTUATION

Percent; Histogram of 120 months from Jan. '77 to Dec. '86

24 (4

20

15

51)

19

13

D

2 2 2

0 1 2 3 4 ' 5 6 7 8 9 10 11 12 (%/Mo.)

ments are bound to come

back to the U.S. In the long

term, the trade balance must

equal the capital-account balance, unless the country goes

"default" or "bankrupt."

(4) The notion of interest

has become obsolete. Such

attractive profit-making

opportunities as speculative

buckets lure financial institutions to stay wthin the noninterest-bearing FX market,

stocks and real estates,

rather than seeking investment opportunities in the

"real" world. Lately, the

American government has

^E*hibit;5>

THE BUCKETS OF SUPERLIQUIDITY AND INTERCHANGEABLY

Private

Sector

Corporate

Sector

CS5

/ ' I $1.1/day

Interest-bearing Financial Institutions it ions 1 ) /

~v r

Foreign Exchange Market V |£ DM I /$ ¥ I I

H H K—w

~\ .r~

(ign E

T

!» c, X» -» SCommodities,

futures, etc.

active FX empire, money now

can travel across national

borders in seconds. Even if

the Bank of Japan tightens

the money supply, a Japanese

banker can borrow an impact

loan instantaneously from

abroad.

(3) Monetary interlinkage

has created dollar-based markets in Japan and yen-based

markets elsewhere. In fact,

the U.S. has created an opportunity to invite a $50-billion investment at home by the Japanese through its trade deficit

with Japan. The dollar-based

trade deficit is nothing but an

accounts receivable for the

U.S., as greenbacks must

eventually be used to buy

something American. It may

make a detour via OPEC or

Brazil, but U.S. trade paydollar by over 40 percent in a

year. The FX empire's profitmaking opportunities on the

exchange itself could reach

over 50 percent per year,

making any interest-bearing

instruments look rather

boring.

• Be ineffective in correcting the trade imbalance. Despite the currency adjustment

24
of 40-50 percent, the U.S.

trade deficit with Japan, and

most countries in Europe, has

not come down, at least in dollar terms. This suggests, on

persistently asked Japan and

West Germany to lower interest rates in order to keep

the large spread with the U.S.

Recently, as the U.S. interest

rate has gone up, the spr,ead

has widened to something like

6 percent per year. That is j

still far too small to attract i

money from Japan or West I

Germany, whose currencies

have appreciated against the

the one hand, that the use of

the dollar to measure the imbalance is a futile effort when

its value, relative to other

currencies, is dwindling. It

also suggests, on the other

hand, that the exchange rate

is a poor instrument by which

to adjust the trade imbalance.

Unlike the days of David

Ricardo and Adam Smith,

when internationally traded

goods were primarily "commodities," the leading exporters today are much more specialized in manufacturing.

The impact of the labor rate

and raw materials is far less

important today than in the

past.

Industries tend to cluster to

gain competitiveness and

flourish as a whole, as in the

case of aerospace in the U.S.,

chemicals in Germany, and

cameras and consumer electronics in Japan. It takes decades to build up the infrastructure needed to excel in

any industry worldwide. Once

built, it again takes a long

time to relocate. Currency

rates are too temporary to

affect corporate decisions to

relocate. Currencies fluctuate. They seem to hit highs

(or lows) every two years.

Plants cant be moved around

at this pace. As a result, higher prices may be passed on to

the market, as in the case of

German cars in the U.S., or

cost is reduced significantly

so as not to pass on the full

impact of the exchange rate

fluctuation to the customer,

as in the case of Japanese

consumer electronics.

Short-term FX

profits are more

attractive than

interest-paying

instruments

It is a lot easier to absorb

the impact of FX rate fluctuations within the existing industrial cluster, or cascade of

old vendors/subcontractors,

rather than relocate the plant

to, say, the U.S., and start

with brand-new vendors and

subcontractors who are at the

starting (high) point of the

learning curve. These clusters have more resilience

against changes in FX than a

straight-forward comparison

of wage rates under a new exchange rate might indicate.

The Group of Five, here

again, wrongly assumed that

a correction in exchange

rates would correct the problem of U.S. industrial competitiveness, and thereby rectify its huge trade imbalance.

• Be extremely sensitive to

macro-economic results and

government officials' announcements,. If FX were reflective of the "fundamentals" of the economy,

then such extreme moves,

creating peaks and valleys,

would not result. This is because economies — that of

Japan or, for that matter, of

the U.S. — do not fluctuate so

vigorously, daily or monthly.

As far as I can see, living in

Tokyo, the Japanese economy

is changing only slowly and

consistently, and I believe the

same is true with the American economy.

From a detailed analysis of

the Reuter and the Telerate

services (information terminals which almost all traders

worldwide rely on today), it is

clear that the daily and even

weekly rates are severely

affected by American officials' public and implied

statements. Exhibit (> is an example of such an analysis of

exchange-rate change, with

indications of captions from

the Telerate news as they

appeared on the screen. Traders watch these screens not so

much with a great knowledge

of the world economy, but

with curiosity as to how their

fellow traders will interpret

the same information. Reading the gravity of the mind of

the traders is often more profitable than knowing the "fundamentals." It is thus the

"announcement" of the fundamentals that drives the FX

market, as opposed to the fundamentals themselves.

• Change in a surge from

one extreme to another. For

example, the yen-dollar rate

changed from a low of 259 in

February of 1985 to a high of

137 in May of 1987, or almost

50 percent — far from the notion of currency "adjust-'

ment." Though drastic, this

was not the fjirst time that the

exchange rate had moved so

significantly. In fact, the history of the pound-dollar relationship before and during the

pre-Great Depression era is

almost as "wild" as the recent dollar-yen relationship

(Exhibit 7). In fact, one could

conclude that the exchange

rate does not "hesitate" at a

certain level, but swings like

a yo-yo in almost a two- to

three-year cycle. The rate of

change is particularly fast at

the cycle's peak or bottom

point (Exhibit 8).

Dramatic switches

The two countries' "fundamentals" obviously do not

switch position so dramatically in such a short term. What

has changed 180 degrees during recent time is the American government's fundamental belief. Several

years ago, the U.S. wanted to

25
•Exhibit 6

YEN-DOLLAR RATE MOVEMENT IN A DAY

Spot rate; March 31, 1987; Japan time Citibank hikes prime rats

Baker worries about Dollar drop

Baldridge sayi market overreacts to sanctions vs. Japan

Baker says bond rate drop due to trade war fears

Baker supports stable Dollar

146.6 r

146.2

145.8

145.4

145.0 L i

BOJ buys

Dollars

(1 billion)

Shoshas issue

huge USS

sell orders

10 12 14 16 18 20 22

^EMibit?/;

DOLLAR/POUND EXCHANGE RATE (1900—1986)

($/£)

2 -

1 L

1900 14 19 30 40 50 60 70 80 86 (Year)

adopt a "strong dollar-stroi.

America" policy known as

"Reaganomics." This policy

has resulted in the twin deficits of the government

budget and foreign trade. The

U.S. recipe was to deal with

the latter first by reversing its

belief to that of "weak" dollars. The two countries' "fundamentals" have changed

consistently over the decade

at about 3 percent per annum,

reflecting the differences in,

for instance, productivity,

rate of inflation and the interest rate. This suggests that

the right exchange rate would

have been ¥170-180 to the dollar at the end of 1987, instead

of the current range of Y140.

As we analyze the currency

market, we need to incorporate this force at work, which

can be described as the "political paradigm." This paradigm is severely affected by

American government officials, since they have voiced

their beliefs, whatever they

may be, more strongly and'

more aggressively thanjprjrbody else,, particularly at

I turning points, or peaks and

valleys. The Reuters of this

world carry basically English

information, and hence tend

to over-reflect thß American,

rather than the Japanese or

the German, points of view,

particularly in the» minds of

money traders.

Reading FX changes

The paradigm is the weighted psychology of the traders

reading as to which way the

exchange rate goes. For ex26
ample, a lot of Japanese

money traders know that

Yl40/dollar is too high and

personally feel that the rate

should bounce back. However, they also know that their

fellow traders around the

world hear much more about

U.S. Treasury Secretary.

Baker's point of view than

that of our Finance Minister,

Kiichi Miyazawa.

People dealing with consumer-packaged goods are

normally sensitive to the

"share of shelf space." They

believe that if one can take up

a larger area on the supermarket shelf for a given prod-

^EKhlbltiB

uct. it can get a higher share

of the market. A similar attitude prevails in the FX market. A higher share of the

screen, particularly with the

Reuter News and Telerates,

which over 90 percent of the

currency traders around the

world watch, tends to dominate the mind share of the

traders, hence impacting substantially on the exchange

rale.

YEN/DOLLAR EXCHANGE RATE (1950 — 1986)

(¥/$)

360 r n

320

280

240

200

160

1950 55 60 65 70 75 85 (Year)

(¥/$)

160

200-

240

280

320

360 *-

Assumptions in

currency model

«950 55 60 65 70 75 80 85 (Year)

From these observations,

we can construct a set of

assumptions about the currency market. For the sake of

simplicity and clarity, I will

use the dollar-yen relationship and the Japan-U.S. economies as key drivers. This

does not mean that such is the

case in the real world. But I

do believe that the simplified

model is a useful first step in

constructing a mathematical

model to explain, and hopefully predict, the unusual behaviors of the existing currency market. I have identified

four fundamental forces at

work which influence collectively to come up with one

number, i.e., the currency exchange rate:

1. Trading power for goods

transfer

2. Financial fundamentals

for capital transfer

3. Political paradigms or

commonly-held beliefs

4. Money traders' desire to

make profits

The so-called "fundamentals" included such

things as relative productivity gains and interest rates. I

have tried to separate the factors affecting the competitiveness of the goods, such as

productivity, from others

which affect the flow of

money in "financial fundamentals," and have included them in "trading power." In this fashion, we can

more clearly understand the

the impact of the currency exchange rate on trade, and the

flow of capital investment as

a separate phenomenon. Let

me explain each of these

forces in more detail:

1. If, for example, color

TV's delivered cost equilibrates between the U.S. and

Japan at ¥140 to the dollar,

automobiles at V180, scientific instruments at Y200 and

27
beef at Y400, the exchange

rate is set as the weighted average of equilibrium costs of

aggregate tradeable goods.

Since not every tradeable industry will try aggressively to

export, however, some dominant products will act as

standards for the rate setting.

Automobiles from Japan, and

lumber and wheat from the

U.S., then, may over-represent the process of exchange

rate setting. Before Japan

and the U.S. exchanged a lot

of capital flow, this relative

trading power was the dominant factor in setting the exchange rate. In the long term,

the currency exchange rate is

predominantly influenced by

the relative competitiveness

of manufactured goods.

However, productivity improvement is a function of the

industry and capital intensity,

and it is difficult to "weight"

all industries. So, we have

tested many relative indices

to examine the long-term fit

with the yen/dollar exchange

rate, and found the wholesale

price index to have the best

correlation. If productivity

gain is high, one can assume

that the manufacturers do not

have to pass the price increase to the end user, hence

WPI may stay relatively flat.

Exhibit 9 shows the correlation between the real currency exchange rate and the

trading power adjusted for

the relative change in WPI

since 1973. We have pegged

the latter at Y265 to the dollar

as 1973 was the year just before the energy crisis, when

the two countries' trade was

balanced, and also it corresponds to the period right

beyond the initial adjustment

phase after the float started.

This long-term trendline indicates that the trading-power-based exchange rate would

still be around Y180-200 at the

beginning of 1987. According

to this theory of relative trading power, the potential for a

certain exchange rate will

have a reverse Gaussian distribution. Since the exchange

rate is singularly set, any

products which are not at the

stable saddle point, or the bottom of this potential distribution, will be either too artificially competitive (left of center, as" viewed from Japan to

export to the U.S.), or too

handicapped (right of center). For example, when automobiles became the dominant

export item from Japan, textiles suffered, but chips had a

lot of breathing room. Japanese chip producers did not

take this margin as a heavensent profit, but instead used it

to reduce their prices in the

U.S., only to be accused of

dumping. The dots on Exhibit

10 are illustrative of the right

exchange rate for a given

product in exporting to the

U.S. from Japan. The white

circles schematically indicate

the right rate for U.S. exports

to Japan.

2. A second strong factor

affecting the exchange rate is

the financial fundamentals.

Fundamentals usually drive

money in one direction or

another, as opposed to the

Financial

fundamentals

drive money in

one direction or

another

trading power driving goods

across national borders. The

exchange rate, according to

the financial fundamentals, is

set primarily so as to equalize

the return on investment. As

such, it is influenced by relative differences in interest

rates, inflation rates and the

risks of investment. It acts as

a two-to-three year, or midterm, counterpoint to the

longer term trendline set by

the trading power. As shown

in Exhibit 11, the difference in

the real (i.e. inflation-adjusted) interest rate gives a

pretty good correlation with

the deviation from the exchange rate predicted by the

long-term trading power

shown in Exhibit 9. Over the

past 10 years, the period with

tföthibtt;.«,*

LONG-TERM EXCHANGE RATE AND

THE TRADING POWER

Yen/Dollar

(V/S)

140

160-

180

200

220

240

260

280

300

320

' ' i

1973 75 77 79 81 83 85 87

28
rEfthlbfUlO»

POTENTIAL CURVE FOR

EXCHANGE RATE — TRADING POWER

Productivity slip

Japan vs. U.S.

1980 85 87

Facsimile

Automobile

CO

PC

• Japan —»U.S. How

O U.S. —»Japan How

100 (V/S)

E*HibiMi^

MEDIUM-TERM FACTOR: REAL INTEREST RATE

Deviation of exchange rate from the trendline set by the trading power

Real interest rate difference (Japan minus U.S.A.)

Stronger

yen

Deviation Q

to

equilibrium. This means that

the currency market could

have multiple solutions, or

saddles in the valley of the

potential, and different points

as "stable," depending on

where the exchange rate is

moving from, a phenomenon

known in physics as hysterisis.

In the past, there has been

confusion in meshing the

effects of fundamentals and

trading power, and treating

productivity, interest rates,

inflation rates and country

risks collectively as variables

also affecting the exchange

rate. That is superficially correct, but we believe it will be

more useful to say, for example, productivity affects trading power, and interest rate

affects the financial fundamentals. One interesting

Japan

higher

Yearly Monthly

a higher real interest rate in

Japan has resulted in higher

yen than the trendline, and

vice versa. The only exception has been the most recent

period, when even the 6 percent interest spread has not

produced stronger dollars.

This unusual period is due to

the effect of the political paradigm described below. It is

expected, therefore, that

within a matter of several

months, the currency adjusts

itself to a more normal trendline.

As we have seen, the currency market behaves in a

non-linear and non-equilibrium fashion, as opposed to,

as most existing models are

constructed, linear and

aspect of the fundamentals,

or the asset movement

theory, is that it does not have

an optimal point per se. For

someone who has transferred

capital at Y220 to the dollar

from Japan to the U.S., that is

the starting point. Traders

frequently "clear their position," and hence their optimal

exchange rate changes with

time.

29
;:E*HIBl«2fc

POTENTIAL CURVE FOR

EXCHANGE RATE BY FUNDAMENTALS Fundamentals slip ' Japan vs. U.S.

1980 85 87

However, longer term investments, such as real

estate, acquisitions of companies, and treasury bills normally lag behind the day-today changes of the exchange

rate. Hence, the stability of

the fundamentals-driven exchange rate has an asymmetric potential curve, with a

steeper gradient toward the

unexperienced exchange-rate

zone, such as the Y130s yen/

dollar range (Exhibit 12).

3. The paradigm in currency markets is like the

"Delphi" method of predicting the future which no one

knows for sure. For example,

by asking a large enough

number of well-informed persons, you would bet that, for

example, a material that

would exhibit superconductivity at room temperature will

be discovered by 1992.

So, even if Prof. Lester :

Thurrow is completely off

base, if a large enough number of influential persons like

him say that the right exchange rate should be Y130

which will move down to Y100

in two years' time, then the

paradigm valley gets deeper,

and people start actually betting on it. As more and more

people buy the yen to enjoy

110 (¥/S)

the appreciation, it will

actually happen that the yen

would climb up to Y100 to the

dollar.

Upward momentum stops

If, on the other hand, a

brave man with great credibility started saying. "No, the

right rate is actually Y200,

since the Japanese economy

is destroyed, and after all, the

U.S. economy is much stronger than people thought." At

that point, when the major upward move stops, and the rate

of exchange-rate change becomes smaller than the interest spread between the two

countries, investing in the dollar will become more atttractive. As people move in the

other direction, they start

making exchange gains as

well as interest gains. It becomes much more profitable

to be buying dollars and investing them in interest-bearing instruments; the U.S.

economy begins to enjoy an

influx of capital and investments. Now most people

would say, "after all, the

right exchange rate is Y200,"

which becomes the new paradigm.

In the real world, however,

scholars and Kaufmans have

seldom influenced the critical

turning points. As shown in

Exhibit 13, powerful (exclusively American) politicians

and high-ranking government

officers have made the turns

and accelerations. Thus, we

have named this force "politiPolitical

paradigms are a

major reason why

exchange rates

are erratic

cal paradigms." The paradigms have been the major

reason why the actual exchange rate has deviated so

erratically from the more

stable exchange rate expected of two other

fundamental forces at work,

namely, trading power and financial fundamentals.

Ordinarily, the political paradigm is a rather weak

force, or a shallow potential to

represent its shaky foundation. When a politician says

that the right exchange rate is

Y94 to the dollar, he is using

simple-minded linear thinking to generate the "J-Curve"

effect to balance Japan-U.S.

trade. This is fundamentally

wrong because the currency

market has no such thing as

the "right" exchange rate.

A paradigm does not have

to be true. It only serves on

aggregate to offer currency

dealers fairly good opportunities to make money, and a

comfortable feeling that

where they are isn't too far off

after all. The current paradigm seems to be around Y140

to the dollar, as Messrs.

Reagan and Baker have expressed their strong point of

view that, "This is where it

should be, and we don't want

it (the dollar) to go down further." It was not so long back

when the same government

created a totally different

30
■■Bmibifefta.»

CREATION OF PEAKS AND VALLEYS IN YEN-DOLLAR EXCHANGE RATE (1977—87)

Volcker "Dollar is

sufficiently weak"

137

-i TT r

'80^ '81 '82 '83

Liberalization of Yen

* Exhibit 14;

POTENTIAL CURVE FOR EXCHANGE RATE

BY PREVAILING THEORY OR "PARADIGM"

Paradigm:

"' ^

1985

Reaganomics

"Strong Dollar «

Strong America"

" *

1986

Plaza Agreement

"Adjust strong

dollar and weak

yen"

250 200

kind of atmosphere, where a

"strong America through

strong dollar" was the governing thought (Exhibit 14).

Assets as a force

The so-called asset

approach — that the movement of the asset itself sets

1987

Punish Japan

"Use currency to open

market and reduce

trade surplus"

150 100 (Y/$)

the rate — is explained as the

force to change the paradigm.

For example, if the exchange

rate is Y150/dollar and the paradigm is that it could be

YHO/dollar; what drives the

rate from 150 to 140 is the

market mechanism that additional purchase of the yen or

selling of the dollar will give

traders attractive gains. So, a

massive purchase of the yen

takes place, only to accelerate the dollar's decline. At

some point, the paradigm

changes its extent, for instance, to 130, although it does

not change its polarity (i.e.,

weak dollar is good). Asset

moves tend to accelerate the

change only to increase the

instability of the market.

4. The traders' desire to

make money may be endless.

I originally thought that the

currency traders needed to

see the market fluctuate in

order to make trading gains.

However, given the enormous short-term volatility

shown in Exhibit 3, their

needs are more than met

through the daily, weekly and

monthly hiccups which are

not necessarily reflective of

the longer-term needs to adjust economic fundamentals

between the two countries in

question. These fluctuations

occur as the foreign exchange

31
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"8'S*

Ego 3 5 a> EC O» .„Eg x c 5 «J .- > 2 S< 8 «=' 8 5 5 <

32
;*E*Hlbit;16

THREE BASIC POTENTIALS

Potential

0

-5

-10

*•-•

> "Y~ / \ A /

\/\ /

-15 Parad gm

-20 ^ \

-25

Fundamentals \ /

-30

Trading power

1 1 1 J ,.. .i

130 140 150 160 170 180 190 (¥/$)

market's self-corrective action from the basic trendline,

which is set as the compounded effect of the three more

fundamental forces described

earlier. Exhibit 15 shows the

monthly fluctuation relative

to the average of the previous

month. What this means is

that, even during a period of

general decline, there are

opportunities within a month

to clear a trader's position

without a large loss and to

take advantage of general

trendlines. While the large

surges based on the political

paradigms have given money

traders opportunities to make

money, the peaks and valleys

are not necessarily created by

the traders. It would be safer

to assume that the traders

have had the "joy ride" with

the paradigms, but they could

be happy without the surges,

so long as the short-term fluctuations yield 4-5 percent

moves per month, or a 50 percent per annum for a constant

winner.

Currency exchange

model using potentials

Using the analogy of the

non-equilibrium theory of

physics, as in phase transformation, we have tried to synthesize the different forces at

work to explain the actual

currency exchange rate. We

define the curve's

—Depth as its impact, i.e.,

if a particular force is working strongly, it will be deeper

— Width as its diffusion,

ambiguity, or ambivalence,

i.e., if there are many different situations which would

make the case diverge, then it

will have a wider valley —

volume of speculative money

in the FX market, and the

variety of goods traded (e.g.,

from beef to missiles) make

the width bigger.

We have not been able to

incorporate the non-linear nature of the market. Such a

treatise would require a study

of the impact of the interest

rate (a factor in financial fundamentals) on productivity

gains (a factor in trading

power). One could argue that

a lower interest rate would

accelerate the capital investment to renew the production

facilities, and hence help the

productivity to improve.

At this stage, we assume

that different forces form independent and different

potential curves (Exhibit 16):

1. Trading power as the longterm and strongest potentials;

2. Financial fundamentals as

the medium-term, strong

potential

3. Political paradigm as the

transient, weak potential,

moving as a function of

time, as the prevailing beliefs change.

As we have seen, the traders' money-making desires

are more than met by daily,

weekly and monthly fluctuations, and therefore we did not

incorporate the fourth force in

our model. A critical point to

note is that these potentials

suggest different optimal and

stable exchange rates, as

shown in Exhibit 17.

Since financial fundamentals are defined as the

rate to equalize the expected

return on investment in the

two countries in N years'

time, it will hold that

(1 + Japanese real interest

rate ij) = (1 + U.S. real interest rate, ij^) x (Y/$ rate in

N years Rj^) -* (Current Y/$,

Rc)

and expecting that

(Y/$ rate in N years, R^) =

(Rate set by trading power,

Rfp) x (1 + Rate of relative

productivity change, rjp)

(Current ¥/$, Rc) = (Rate set

by trading power, R-pp) x (l

1 - Deviation from the rate set

by trading power, Ajp).

Ignoring the second-order

terms, assuming annual

changes are smaller than 10

percent, and making N—1, reflecting the medium term nature in the impact of the financial fundamentals, we have

ATP = (ij - iA) +. rTP

(1)

33
%E*Hlbltvi7*I

SYNTHESIZED POTENTIAL CURVE

Paradigm:

.^«■■Ul 111 ill. II

130 140 150 160 170 180 190 200 210 220 230 (¥/$)

In other words, the deviation from the exchange rate

set by trading power is equal

to the sum of the interest

spread and the relative productivity slippage. Since we

have empirically discovered

that Tjp has been most closely associated with the relative

difference in the wholesale

price index, we have

ATP = (ij - iA) + (WPIj -

WPIA) (2).

The result of our calculation

shows that

• A rather stable band of

"most likely" yen/dollar exchange rate emerges as a result of the composite effect of

trading power and financial

fundamentals, using Equation (2) (Exhibit 18). Width of

the band is calculated using

our best estimate of the potential curves for the two forces

(TP and FF), and using the

probability of transition from

one point to another, reflecting the gradient of the potential curve, as schematically

shown in Exhibit 19.

The transfer matrix is used

to reflect the non-equilibrium

SE*hlbit*18*

MEDIUM-TERM EXCHANGE RATE AND

THE FINANCIAL FUNDAMENTALS

Yen/Dollar

(¥/$)

140 1

037)

Actual rate

- Instability

Composite

trendline,

reflecting trading

power and

financial

fundamentals

1/1977 10/78 3/80 12/80 10/82 3/84 2/85 12/86

34
*sE*HlblM9;

PROBABILITY OF TRANSITION FROM TIME t TO t+At

nature of the currency exchange rate. These results indicated that except for the occasional anomalies based on

political paradigms, we can

pretty much explain the recent past changes in the yen/

dollar exchange rate using

our model, based on the two

principal forces. The recent

rate at Y137/dollar is clearly

far from the rate explainable

using the two principal forces,

and hence is expected to be

unstable. This model also enables us to predict the stable

zones in the future, given the

prediction on the WPI and

real interest rates.

• When the third force, political paradigms, is add to

this, we begin to see multiplestable answers, or the saddles

in the potential curve. Exhibit

17 shows the composite potential curve for three different

values of the political paraPolicy makers

should keep quiet

about what the

'right' exchange

rate is

digm curve's central value,

i.e., 220,180 and 140 yen. If the

prevailing paradigm were to

become "180," it seems to accomplish the strongest

strength and stability for the

exchange rate at ¥180 to the

dollar, although another, a bit

shallower stability is also

observed at around Y100.

With the paradigm of ¥140,

there are three rather shallow

saddle points at ¥140, ¥160

and ¥180. There will be some

kinetic energy needed to overcome the small hill between

¥140 and ¥160, in order for

the current exchange rate of

¥140 to go to another1 stable

point at ¥160.

• Reflecting the hysterisis,

i.e., multiple solution depending on history, we come up

with totally different solutions

depending on where we start.

Even with the static paradigm of ¥140 — i.e., people

believed in ¥140 all along —

the optimal composite exchange rate could be different

depending on where one

starts. Exhibit 2« shows that,

as time goes on. the probability distribution of where the

synthesized potential is stablest (or deepest) takes a completely different pattern. If it

starts at ¥145, it tends to

¥140; ¥175 tends to ¥180; and

¥150 splits into ¥140 and

¥160. This kind of phenomenon is not unusual in

physics, as in the martensite

transformation in working

stainless steel. Depending on

minute factors and speed affecting the transition, a totally different phase diagram

emerges.

Unlike metallurgy, however, a currency demands only

one exchange rate at a given

time. This means that while

the rate may be set by the

minutest factor in transition,

people living in the real world

35
Exhibit 20'

HYSTERISIS

(Trading Power - 180. Financial Fundamentals - 160, and Political Paradigm « 140 Y/$)

135 140 145 150 140 145 150 155 160 175 180 185 (V/S)

, , 1 -i i r 1 ' ' ' ' '

• • • • O °„*.#

O « • • O O •

• o

• Q • • • m

• • •

• a

• • •

• * •

Time Most likely (deepest in curve)

• Quite likely

£E*hibit2ik

IMPACT OF PARADIGM CHANGE — I

Probability distribution of yen/dollar rate

• Likely

O Outer limit of likely

Central value

of paradigm

curve ( 220

130 140 150

r ~T

160

—I—

170 180 190 (¥/$>

—1 1

> • •

• • •

•

• •• •• o_

• • •

• • • •

• • • o

*•*•*• •_ o • • • o

• • • •

I * • • • • o

• • • • •

•

•

•••••

• • o •

• « • o • •

• • • • •

• • • • • _ o

. • • • • . •

o • • • • • m

• • • • • •

• • • • •

must pay for it dearly. For

example, if the paradigm of

Y140 acted strongly to bring

up the rate to Y145, then exporters of goods, whose

equilibrium point may be

Y180, will have to pay the

price for it.

• Next, we can see how the

exchange rate is affected by

the change in paradigms. Exhibit 21 shows how ambivalent it gets when the prevailing belief changes from ¥220/

dollar to Y140. However, it

also shows that the rate could

quickly bounce back to the

Y155-187 range as soon as the

paradigm swings back toward Y220. In fact, if one

traces the outer bounds of the

dark dots, most probable

range, one finds that once paradigm changes, tiie real rate

is quickly pulled back by the

more fundamental forces.

Another simulation of the

probability distribution of

yen/dollar exchange rates is

"shown in Exhibit 22. Here, the

paradigm change is lower in

magnitude and slower with

respect to time. In this case,

while the composite potential

spreads all over the place,

meaning any rate from Y130

to Y190 is probable, the

deepest valley lies in a

reasonably narrow band of

Y163 and Y184. Right after the

turning point, the probability

spreads into three distinctive

possibilities, and shows,

again, the possibility of great

confusion and instability.

These probability distributions over time show a remarkable resemblance to the

real life fluctuation of the currency. They also demonstrate

that while the two principal

forces create a rather stable

band of rate change, the political paradigms can create

extreme peaks and valleys

that can deviate far from the

stable zones.

In sum, we have been able

to demonstrate that

• Long-term rate correlates with trading power.

• Medium-term rate is

affected by financial fundamentals.

• Paradigm, though possessing a weak potential, can

swing the exchr.: • rate when

it is unsure and moved over

time.

• Indeed, multiple answers

are possible in the exchange

rate as different and independent forces interact to determine a single rate.

• A probability distribution, such as Exhibit 14. best

correlates with the exchange

rate fluctuations in real life.

• When the paradigm is removed, or changed, the rate

can approach a more normal

one set by the two principal

forces.

Implications of the

potential model

Admittedly, our model at

this stage is to a large extent

intuitive, although we have

made our best effort to plug in

available numbers. While we

are still trying to develop

more empirical and/or theoretical methods to come up

with the shape of each potential, we believe this approach

36
merits wide criticism and

study, for, unless our

approach is fundamentally

wrong, the implications we

can draw from these simulations are quite significant:

• We have observed that

the short-term profit-making

opportunities in the FX market is much more attractive

than any interest-bearing instruments. This means that

the governments, trying to

adjust flow of goods and

money through adjustment of

interest rates, are out-dated,

or are not going to be effective, to say the least. However, as we have seen, the interest spread between the two

countries can affect the

medium-term flow of funds,

and hence the exchange rate.

However, when there is a

strong political paradigm to

push the dollar value down

while at the same time trying

to accomplish the infeux of

foreign money into the U.S.,

this is an infertile effort.

To make the interest-based

policy effective, the political

paradigms must be removed,

or be realigned to be in concert with the direction of the

two principal forces at work.

Government should recognize

that long-term competitiveness can result only through

curbing inflation, as evidenced in WPI, which in turn

is accomplished through real

industrial productivity improvements. It should also

A trade

imbalance, per

se, does not

change the

exchange rate

recognize that medium-term,

i.e., two to three years, it can

adjust the currency exchange

rate by the interest rate.

^Exhibit 22

IMPACT OF PARADIGM CHANGE — II

Central value

of paradjgm.

curve

adjt|m

CüüD

130

l—

150

—I—

170 190 210 (V/$|

= Tim»

c*> o

o » o

• • • • o

• • • • o

• • • • • o

• • o • • o

• • o • • • o

• • • • o o

• < • • • •

• • • • o o

o • • • • • •

• • • • • o o

o • • • • • •

• • • • • o

o • • • • •

• • • • • o

o • • • • • o <

o • o • • • • <

o

o

However, there is a certain

limit to this ability, because

the changes in the interest

rate is going to affect the WPI

and/or productivity gains.

This is one of the reasons why

the currency is non-linear.

However, we have not fully

developed the non-linear treatise in our model at this stage.

• Policy makers and renowned scholars should be silent on where the "right" exchange rate is. This eliminates the impact of an unstable paradigm, and allows the

rate to be set by the two principal forces only, trading

power and financial fundamentals. That sets a much

stabler and slower movement, and removes unnecessary volatility in the market.

Although speculative market

participants may still want to

enjoy profit-making opportunities, such needs are satisfied completely by the shortterm fluctuations, amounting

to 4-5 percent per month.

These "hiccups" will center

around the fundamental

trendline, and will not dare

deviate from it too far. The

money traders are basically

cowardly people by virtue of

the fact that it ts a high-risk

zero-sum game. They can be

likened to a scared swimmer

whose toe must touch the bottom of the river bed. However, if experts and authorities

37
say that he can go deeper and

enjoy a faster flow without

fear, he'd be tempted. The

lack of such advice, on the

other hand, will scare him

enormously, and he. as well

as his colleagues, will tend to

swim back to the shoreline.

• A trade imbalance, per

se, does not change the exchange rate. A bilateral trade

imbalance is the result of the

two countries' trading power.

If Country A keeps buying

goods from Country B. it will

run out of money and stop.

However, the money left in

Country B must be used. If it

is used"to improve productivity and social infrastructure,

then the trading power and

fundamentals of Country B

will improve, and then, and

onlv then, the exchange rate

will turn in B's favor. If. on

the other hand, Country B

could not find the use for the

excess money and recycled it

to Country A, then the net

position is unchanged. In the

long term, trade deficit must

equal capital account.

The exchange rate changes

as a result of trade imbalances, only because of the paradigm that higher (or lower)

rates reduces the imbalance.

Often in today's developed

world, trade imbalance is the

result of industrial specialization, rather than international

competitiveness. So long as

there is a commensurate recycling of money, it should

not fundamentally affect the

exchange rate per se.

• Government intervention

in the market tends to make

money traders more aggressive. If the Bank of Japan or

New York's Federal Reserve

Bank "intervened," it tends

to create statistically more

"winners" than losers in the

market. The notion of a zerosum game is the only built-in

stabilizer in this already unstable market. It is the fear of

losing that makes the market

recover its sense of balance.

If the government is ready to

buy dollars when everyone

wants to sell, it acts as a

volunteer to lose. "Leave

them alone and give them no

hint" is the best way to make

use of the two stronger forces,

i.e., trading power and financial fundamentals.

Acknowledgement

I would like to thank colleagues ot mine at McKinsey

& Company, Inc. particularly

Mr. Akira Kameyama for the

historical trend analysis and

Mr. Toshiki Sumitani for the

modeling of the currency market used here.

/9274

CSOs 4100/0298

38
ECONOMIC

MOF TAX BUREAU'S ROLE IN REVISING TAXATION SYSTEM DISCUSSED

Tokyo SENTAKU in Japanese Feb 87 pp 122-125

[Text] The Ministry of Finance (MOF) Tax Bureau staff is merely 100 strong.

It is the smallest bureau within the ministry. Of the budget-related three

bureaus, compared with 350 of the Budget Bureaus and 370 of the Financial

Bureaus, the Tax Bureau is significantly smaller.

Nevertheless, as a section that handles the revenue side of the budget, it

is the second most Important bureau in the ministry after the Budget Bureau.

When we look at 17 vice ministers since 1965, we see that 12 came from the

Budget Bureau, 4 from the Tax Bureau and 1 from the Banking Bureau.

The Tax Bureau's greatest work is the yearly tax revision. FY 1987 is the

first year of major tax reform since SHOUP Recommendation in 1949. For this

reason, the average time for the staff to leave the office has been 4-5 am.

But they are committed to working behind the scenes in the tax reform, supporting the Liberal Democratic Party's [LDP] Research Commission on Tax System

(chairman: Sadanori Yamanaka) and the government's Taxation System Council

(chairman: Takekazu Ogura). They know too well that for bureaucrats to be

spotlighted regarding taxation—a matter concerning the basis of democracy—

would be disadvantageous.

Nevertheless, it is a well-known fact that the government's Taxation System

Council is the spokesman representing the Tax Bureau. Even the powerful LDP

Research Commission on Tax System merely acted on a stage set up by the

bureau. This is clearly demonstrated by the fact that in spite of fierce

opposition, two major reforms—introduction of sales tax and interest tax

was decided. The MOF Tax Bureau—a small group of experts—is the behindthe-scene producer of the tax system reform.

Failures of 1975-85 As Springboard for Change

For the MOF Tax Bureau, 1975-85 was a decade of repeated setbacks. First of

all, there was the so-called "General Consumption Tax" detailed in the FY 1979

Tax Revision Recommendation which the government's Taxation System Council

recommended to implement from FY 1980.

39
This new tax was recommended in order to reduce national debt which had

become very sizable since the deficit-financing government bonds were initiated

in FY 1975. It had a strong supporter in then Prime Minister Ohira, a former

MOF official, and persevered all the way to become the election campaign issue

But the results was disasterous. MOF's dream died when the LDP lost heavily

in the general election.

Next was the Green Card System. It was taken up in the FY 1980 Tax Revision.

The bill went through the Diet and was scheduled for implementation from

January 1984. But when a large-scale fund shifting took place, the plan was

frozen and later abandoned. Ostensibly this proposal's purpose was prevention

of abuse of the tax free interest saving systems such as maruyu and postal

savings and inclusion of interest and dividend incomes in the taxable income.

The Tax Bureau's real aim, however, was to lay the foundation for introduction

of tax payer I.D. numbers.

In addition, in the FY 1984 1 trillion yen revenue neutral plan, it failed in

imposing tax on office automation (OA) equipments, and in FY 1985 the LDP's

Research Commission on Tax System put an end to the plan to impose low rate

tax on interest on tax free interest savings.

Meanwhile the tax revenue trend during this period of stable growth of

Japanese economy had changed from the 1965-75 period when natural increase in

revenue was taken for granted. There was a sizable loss of annual revenue of

3.33 trillion yen in FY 1981 and 6.11 trillion yen in FY 1982. Amidst this,

it was natural that the Tax Bureau became downhearted and its relative status

within MOF declined. It can be said that for the Tax Bureau, the 1975-85

decade was a dark era.

But the social climate was gradually changing. One was a growing dissatisfaction

with the unfair taxation system among salaried workers whose tax burdens were

in a real sense increasing.

Meanwhile, since deficit-financing government bonds were issued, the government's financial state has been becoming steadily worse. At budget compilation time each year, the MOF has been preoccupied with the task of filling

the huge gap between revenue and expenditure. One way was tax increase. The

industrial sector was asked to shoulder this burden primarily. This is why

Japan's effective corporate rate of tax became the highest among the developed

nations at 52.92 percent. The salaried workers agitated for correcting

unfair taxation and the industries cried out against increased tax burden.

The backdrop for tax reform was thus established. The Tax Bureau did not

miss this chance.

A "Realistic Approach" That Accounts for Political Initiative

The Tax Bureau announced the starting of tax reform in the FY 1985 tax

revision recommendation by the government's Taxation System Council. It was

submitted to Prime Minister Nakasone on 19 December 1984. Prefacing the

40
document with—-"though it is unusual to raise this issue in an annual

recommendation," it expressed the bureau's determination in these words:

"Now is the critical time to effect a radical and fundamental revision

regarding both direct and indirect taxes. It should not be a piecemeal

patch up solution but a fundamental revision."

In writing this report, the Tax Bureau was convinced through the members of

LDP's Research Commission on Taxation System such as then-chairman, Mutsuki

Kato, then-advisors, Tatsuo Murayama and Sadanori Yamanaka, and then-Vice

Chairman, Ganri Yamashita, that the party's situation had changed from the

time when the "General Consumption Tax" was introduced. Moreover, it was

aware that the business leaders led by then-chairman of Federation of Economic

Organizations Yoshihiro Inayama were strongly for breaking the traditional

pattern of increasing corporate tax to take care of the government's financial

rebuilding effort. The Bureau conducted thorough "feasibility study."

But at that point the Tax Bureau did not have a clear-cut policy regarding

this major tax reform since the Shoup Recommendation. It was still entrenched

in pursuit of an "ideal" tax structure of the 1975-85 era. The man who

shifted gear and led the bureau to the current "realistic approach" was

Masaru Mizuno who became director general of the bureau in June 1985.

If we characterize the Budget Bureau as power oriented and the three monetary

bureaus as market oriented, the Tax Bureau can be described as system oriented.

This is because it emphasizes systematic theory in dealing with taxation

which requires a sense of intricate balance. As a result, the Tax Bureau

tends to fall into unrealistic idealism. An example of this is the Green

Card System which sought to establish a consolidated tax system.

Tax Bureau Director General Mizuno is a well known tax professional. Since

joining the ministry in 1955, he has been in the tax field exclusively. He

is not only well versed in tax theory, he is thoroughly familiar with the

weight of politics on tax legislation.

Since the day of his appointment, the Bureau has been in a state of tension

since Mizuno works hard such as staying late at night to review papers.

Throughout endless nightly discussions, Mizuno has persuaded his staff to

pursue realistic ideals while compromising political reality, according to a

mid-level Tax Bureau official.

In the personnel changes of 1986, Mizuno remained as director general as well

as Councilors Tsunaaki Oyama and Mamoru Ozaki. Mizuno appointed Tadashi

Ogawa, the bureau's foremost theorist, as the director of the Coordination

Division. Koji Tanami and Nobuaki Usui, top ranked in their classes, were

appointed as directors of the First Tax Division and the Second Tax Division.

Furthermore, Coordination Division Director Eisuke Hamamoto was appointed as

the director of the Overall Coordination Division, Second Tax Division Director

Sohei Hidaka as the secretary to the minister and Tax Bureau Senior Officer

41
for Research and Planning Tadashi Iwashita as the director of the Public

Relations Division. By this line-up, the MOF made clear its stance to

tackle tax reform as the ministry's project.

The realistic approach became clear to everyone in September 1985 when the

Taxation System Council was asked to study revision of taxation system.

Prime Minister Nakasone directed that first priority be given to tax reduction: "first of all to come up with measures for reduction and rationalization

of tax burden and then to come up with an overall direction for tax reform,

including measures for securing fiscal resources for tax cuts."

The Tax Bureau was involved in making this inquiry statement, but Nakasone's

obvious political tactics predicated on the upcoming election was widely

criticized within the bureau. Not only was it incompatible with the MOF

position, the staff feared the politicians would take only tax reduction.

In the end, however, they accepted the inquiry statement with a condition

that revenue neutral would also be emphasized, and gambled on siding with the

Nakasone administration. It is true that such Tax Bureau performance which

allowed the politicians to take leadership was criticized by influencial

former MOF officials and others as "Tacking principles of taxation." But as

a result of choosing a realistic approach, the bureau was able to have a good

grip on promotion of tax reform, that the predecessors were not able to accomplish.

The Cost of the "Great Reform"

Although the Impression after the fact is that the Tax Bureau was in control

throughout the entire process, in reality it had to deal with a succession

of obstacles.

The trial that came almost simultaneously with the inquiry session was the

addition of special members to the government's Taxation System Council. Of

the 10 "rough horses appointed by Prime Minister Nakasone in September 1985,

the only one that the Tax Bureau could control was former Tax Bureau Director

General Takashi Hosomi, the president of the Overseas Economic Cooperation

Fund. Koji Nakagawa, Nomura Research Institute President, Kiyoshi Iijima, a

political commentator, Shunpei Kumon, Tokyo University Professor, were all

members of Nakasone's brain trust. Although the Tax Bureau elected to team

up with the Nakasone administration, the addition of these members indicated

the prime minister's dominance in the government's Taxation System Council

deliberations.

Here again the Tax Bureau's response was quite realistic. Basically the

strategy was to accommodate the prime minister by placing rough horses as

deputy-chairmen of three special committees and at the same time, to try to

explain to these tax amateurs the basic principle of tax reform.

42
A high ranking official of the bureau stated that, "though they said this and

that in the beginning, when we explained logically, step by step, they

understood in the end." Compared to the task of persuading Tax-zoku members

representing special interest groups who employ unlogical arguments, the

"rough horse" persuasion was easy.

In fact, Jiro Ushio, chairman of Ushio Inc., the Second Special Committee

Deputy Chairman, a strong advocate of tax system reform for salaried workers,

for instance, offered strong support to the bureau's undertaking. It was

ironic that comments from Chairman Ogura, a one time bureau spokesman for an

idealistic, consolidated taxation system, posed the greatest difficulty to

the bureau.

The most threatening incident for the bureau was Prime Minister Nakasone's

campaign promise in last July's double election that: "I will not adopt

what is called large-scale indirect tax that the citizenery and the party

members oppose." If we carefully examine his comment, it is clear that he

chose his words carefully so as not to be committed to a particular course

of action, but it was clear that the public could not be depended on to make

a detailed interpretation.

There was also a concern that perhaps Prime Minister Nakasone's campaign

promise reflected his true intention. Although the bureau went on the Nakasone

bandwagon, no trust relationship such as the one the bureau had with former

Prime Minister Ohira existed between them. The alliance was merely a practical

tactic for realizing the goal. At this point, the Tax Bureau led by its

director general Mizuno feared for the collapse of their "realistic approach"

that assumed compromise with politicians.

There were differences of opinion within the bureau regarding the course of

action to be taken after the overwhelming LDP victory. Councilor Mamoru

Ozaki, who is in charge of indirect taxation, proclaimed that the government's

Taxation System Council that had been suspended during the election should

reconvene soon and the citizenry be informed regarding the content of the

large-scale indirect tax package.

In contrast, Director General Mizuno's stance was cautious, saying: I will

decide after we hear from each and every LDP Diet member regarding what he/she

said in respective electoral district and what he/she is thinking of now."

In the end, the government's Taxation System Council did disclose three

proposals regarding the "New Indirect Tax" in late July, but at the same time,

the Tax Bureau decided to expound on the need for increased indirect tax and

tax on interest as a fiscal resource for tax cut in the tax reform package.

This is the so-called "Pilgrimage to 500 people." Its target was not limited

to the ruling party members, but extended to the opposition parties, economic

and media circles. It was little wonder that this PR caravan for realization

of tax increase would not be welcomed.

43
There were many problems that the Tax Bureau had to clear between summer and

year end. A clever strategy of preparing three options was adopted to deal

with the distribution industry which would oppose to retail sales tax. Three

options were the manufacturer's sales tax (Plan A); sales tax which exempts

sales between businesses (Plan B); and Japanese-type value added tax (Plan C).

Representing primarily the manufacturers, the Federation of Economic Organizations' Taxation System Committee Chairman Eizi Suzuki publicly endorsed

Plan C in order to banish Plan A and neutralized the voice of the distribution

industry in the federation. The Tax Bureau used the classic tactic of divide

and conquer.

But then, persuading Prime Minister Nakasone who at that point was revealed

as a Plan A supporter was not easy. LDP Research Commission on Tax System

Chairman Yamanaka's help was needed.

Yamanaka had been a young lieutenant along side Nakasone in the old Kono

Faction. He can speak on an equal footing with the Prime Minister. Moreover

he is an expert on the tax system who boasts that, "I taught taxation to

Mizuno."

It was only natural that the Tax Bureau emphasized laying groundwork to get

Yamanaka's support. It was true that in the beginning, they feared "Lone Wolf"

Yamanaka's recklessness, but in reality, there was no need to fear. Although

there were disagreements in detail—postponing inheritance tax reduction and

mutilating a plan to revise deductions from salary income, there was no basic

disagreement between the two regarding the main points such as tax on interests

and the Plan C. Yamanaka stressed the process and although the Tax Bureau

complains that "because of Chairman Yamanaka, our work greatly increased,"

(Tax Bureau high-ranking official), the difference was limited to that.

Yamanaka formed LDP Research Commission on Tax System Executive Committee

composed of pro-MOF figures—Advisor Murayama, Vice Chairman Yamashita (Sub

Committee Chairman) and himself. Thus the three legged race team between the

party and the Tax Bureau was created.

Then came the meeting between influencial members of the LDP Research Commission

on Tax System and Prime Minister Nakasone in October. Superficially both

parties agreed to respect Nakasone's campaign promise but the predominant

interpretation is that Yamanaka pressed for adoption of Plan C and abandonment

of Plan A. In order to implement the tax system reform the prime minister had

no recourse but to agree.

At this point, the bureau was prepared to compromise that businesses with

annual sales of Y100 million or less would be exempted from sales tax payment

and the categories exempted from sales tax would be expanded. Also the

bureau was aware that regarding its last hurdle—tax on postal savings—it

would have to approve an autonomous management of some postal savings funded

by the Ministry of Posts and Telecommunications. In order to realize a major

reform, a certain price has to be paid and that was the method adopted by the

Tax Bureau in controlling Yamanaka's Research Commission on Tax System.

44
Savior for Declining MOF Position

The critical focus of the ordinary session of the Diet which convened on

26 January was tax and defense expenditures. The Tax Bureau submitted four

bills: "The Bill to Revise A Portion of Income Tax Law," "The Sales Tax Bill,"

"The Bill To Implement the Revised Income Tax Law and the Sales Tax Law" and

"The Bill to Revise a Portion of the Special Taxation Measures Law." The

Diet was in an uproar from the beginning because the prime minister's policy

speech did not mention sales tax. A high-ranking Tax Bureau official was

not overstating the case when he commented that "we cannot rest peacefully

at night until the bills are passed."

In the beginning, the Tax Bureau wanted to submit one tax system reform bill

but the cabinet's Legislation Bureau showed reluctance about including new

sales tax proposal in one comprehensive bill. Thus the bureau was forced

to set it up separately. But in order to attain revenue neutral, the

implementation bill contained an implementation date for tax cut as well as

an introduction date for sales tax. That is, the bureau took care to insure

that the sales tax bill alone will not go down.

But there is no question that the tax system revision related legislative

proposals will be used as a confrontation weapon between the ruling party

and the opposition parties. Already the four opposition parties—Socialist,

Komeito, Democratic Socialist and Shaminren—organized a "Committee to oppose

Sales Tax," and has begun to actively campaign for opposition.

In any case, the Tax Reform will become a reality if its final obstacle—Diet

deliberation—is cleared. Then, there is no doubt that the Ministry of

Finance whose declining status has been noted as Japan's fiscal situation

worsens, will make a comeback and its greatest contributor, the Tax Bureau,

will "power-up" its position.

11460/12851

CSO: 4106/099

45
\o This is a U.S. Government publication. Its contents in no

way represent the policies, views, or attitudes of the U.S.

Government. Users of this publication may cite FBIS or

JPRS provided they do so in a manner clearly identifying

them as the secondary source.

Foreign Broadcast Information Service (FBIS) and Joint Publications Research Service (JPRS)

publications contain political, economic, military, and sociological news, commentary, and other

information, as well as scientific and technical data and reports. All information has been obtained

from foreign radio and television broadcasts, news agency transmissions, newspapers, books, and

periodicals. Items generally are processed from the first or best available source; it should not be inferred that they have been disseminated only in the medium, in the language, or to the area indicated.

Items from foreign language sources are translated. Those from English-language sources are

transcribed, with the original phrasing and other characteristics retained.

Headlines, editorial reports, and material enclosed in brackets [ ] are supplied by FBIS/JPRS.

Processing indicators such as [Text] or [Excerpts] in the first line of each item indicate how the information was processed from the original. Unfamiliar names which are rendered phonetically or

transliterated by FBIS/JPRS are enclosed in parentheses. Words or names preceded by a question

mark and enclosed in parentheses were not clear from the original source but have been supplied as

appropriate to the context. Other unattributed parenthetical notes within the body of an item originate

with the source. Times within items are as given by the source.

SUBSCRIPTION/PROCUREMENT INFORMATION

The FBIS DAILY REPORT contains current news and information and is published

Monday through Friday in 8 volumes: China,

East Europe, Soviet Union, East Asia, Near

East & South Asia, Africa (Sub-Sahara),

Latin America, and West Europe. Supplements to the DAILY REPORTS may also be

available periodically and will be distributed

to regular DAILY REPORT subscribers.

JPRS publications generally contain less

time-sensitive information and are published

periodically. Current JPRS publications are

listed in Government Reports Announcements

issued semi-monthly by the National Technical Information Service (NTIS), 5285 Port

Royal Road, Springfield, Virginia 22161 and

the Monthly Catalog of U. S. Government Publications issued by the Superintendent of

Documents, U.S. Government Printing Office, Washington, D.C. 20402.

U.S. Government offices may obtain subscriptions to the DAILY REPORTS or JPRS

publications (hardcovers or microfiche) at

no charge through their sponsoring organizations. DOD consumers are required to

submit requests through appropriate

command validation channels to DIA, RTS2C, Washington, D.C. 20301. (Telephone:

(202) 373-3771, Autovon: 243-3771.) For

additional information or assistance, call

FBIS, (703) 527-2368, or write to P.O. Box

2604, Washington, D.C. 20013.

The public may subscribe to either hardcover or microfiche versions of the DAILY

REPORTS and JPRS publications through

NTIS at the above address or by calling

(703) 487-4630. Subscription rates will be

provided by NTIS upon request. Subscriptions are available outside the United States

from NTIS or appointed foreign dealers.

Back issues or single copies of the DAILY

REPORTS and JPRS publications are not

available. New subscribers should expect a

30-day delay in receipt of the first issue.

Both the DAILY REPORTS and the JPRS

publications are on file for public reference

at the Library of Congress and at many

Federal Depository Libraries. Reference

copies may also be seen at many public and

university libraries throughout the United

States.