ANALYSIS: The yen fell nearly 10 per cent during the last two months of 2001 and is now back down in the 130s against the US dollar for the first time since 1998.

Japanese and US authorities appear to have jointly encouraged this slide. Tokyo says it reflects economic fundamentals; Washington hints that it favours broader monetary expansion through purchases of US treasuries.

Regrettably, the role that the euro could play in a more coordinated currency adjustment has been neglected. The weaker yen policy is doomed to fail if its impact on the currencies of its main trade partners, the US and the rest of Asia, is not offset by a stronger euro.

Washington's implicit endorsement of a yen weakening could surprise at first glance. Last June, leading US manufacturers were complaining to Mr Paul O'Neill, Treasury secretary, that their products were being priced out of domestic and foreign markets by an overvalued dollar. Since then, the external value of the greenback has continued to appreciate.

Despite the recession and the September 11th attacks, its trade-weighted value against the other main currencies rose 8 per cent last year, matching its 2000 gain.

Even so, given the current state of the global economy, there is no immediate alternative to the strong dollar. From a US perspective, since there is no growth abroad, it is more effective to promote a domestic-led recovery through monetary and fiscal stimulus than through currency depreciation.

Keep in mind, too, that during the 1990s, the US economy reaped the benefits of globalisation by importing cheaper goods and capital. Imports now account for more than 30 per cent of domestic demand for goods, against barely 20 per cent at the end of the 1980s. The record current account deficit has been completely financed by foreign direct and portfolio investment net inflows.

Conversely, the rest of the world is as heavily dependent on US domestic growth as the American economy is on foreign capital. During the second half of the 1990s, US imports contributed to half the increase in total imports among members of the Organisation for Economic Co-operation and Development.

As a result, for the rest of the world, and especially for Asia, a weaker dollar would be even less bearable now that demand from the US has fallen. However, this does not imply that an ever-stronger dollar is desirable. On the contrary, appreciation increases the risk of a sudden and dramatic collapse in its value, which might transform the current world recession into a devastating depression.

The world exchange rate system should be regarded as tri-polar. Contrary to a widespread view, the main current imbalances in the forex markets do not stem from the US currency per se but from the yen (too strong) and from the euro (too weak). The situation today is very different from that in the mid-1980s, just before the Plaza agreement; at that time, the dollar was substantially overvalued against each of the main currencies.

Against the current backdrop, a stronger euro would provide a double benefit for the world economy. First and foremost, it would help to remove the main impediments to the much-needed yen weakening. In theory, the Bank of Japan's ability to weaken the currency is unlimited: it can print as many yen notes as needed. But in practice, the move would backfire if it triggered either a dollar boom-and-bust or a new round of beggar-thy-neighbour devaluations across Asia, as experienced in 1997/98. A much stronger euro would thus facilitate the depreciation of the yen by offsetting its impact on the trade-weighted exchange rates of the US and other Asian currencies.

Second and more incidentally, a stronger euro would boost European domestic demand through lower inflation and interest rates. The euro zone would thus take a more active part in the global recovery, instead of just waiting for external stimulus.

The bottom line is, if the Bank of Japan decides to purchase foreign bonds this year, it would be wise to buy predominantly euro-denominated assets. Such a policy would help to achieve the most desirable orderly realignment between the yen and the euro, leaving the trade-weighted exchange rate of the dollar fairly stable.

The writer is head of strategy and economic research at Société Générale Asset Management in Paris