The long bureaucratic struggle over whom to name as the next Governor of the Bank of Japan is over. Prime Minister Koizumi has chosen a career BOJ insider, Toshihiko Fukui, a man who is unlikely to rock the boat. The BOJ's hidebound policies are usually blamed for Japan's deflation. That guilt is real, argues Deepak Lal, but there is another culprit: American economic policy toward Japan.

It is now widely recognized that an unintended consequence of the "Asian" economic model was an increasingly inefficient allocation of capital. Japan's chronic slump is a case in point. Artificially low domestic interest rates in the late 1980s promoted capital-intensive investment, driving down the rate of return on capital from an average of around 12% in 1952-1973 to less than 2% in 1996.

But what still needs to be explained is the timing of Japan's boom and bust over the last 15 years, as well as the reasons for the duration of the country's ongoing slump. In their excellent book Dollar and Yen , Ronald McKinnon and Kenici Ohno provide an answer: the recurrence of endaka fukyo , a "strong yen recession," which the authors attribute to a "strong yen syndrome" rooted in persistent trade frictions between the US and Japan.

Ever since Richard Nixon took the dollar off the gold standard and exchange rates were floated worldwide, the US has sought to tackle its chronic bilateral trade deficit with Japan by pushing for a strong yen. Real and threatened action against Japanese exports forced Japan to comply rather than risk a trade war, with the Bank of Japan (BOJ) delivering the requisite appreciation through tight monetary policy.

Thus, while liberalization of Japan's capital market in the early 1980s tied Japanese and US interest-rate movements, Japanese interest rates were discounted by the expected rate of currency appreciation. As long as US interest rates were high, Japanese interest rates remained fairly positive, allowing the BOJ to moderate the effects of the yen's appreciation by easing domestic monetary policy.

But this ended after 1985, as the so-called "Plaza Accord" - agreed by the central banks of France, Germany, the UK, the US, and Japan - weakened the dollar by 30%. Massive yen appreciation led to a Japanese recession in 1985-86, and the BOJ lowered interest rates to near zero. Even with the tradable sector suffering due to the strong yen, capital-market liberalization meant that the capitalized value of future income streams, particularly from land, soared, as the interest rate at which they were discounted fell.

This was the start of the great Japanese asset-price bubble. As the yen's strength undermined foreign demand for Japanese output, rising asset values turned domestic demand into the engine of the economy, and Japan rapidly grew out of the recession. The BOJ hailed this outcome, since it gave the tradable sector time to adjust to the stronger yen. The Japanese government also was happy; having just restored fiscal balance after the oil-price shocks of the 1970's, it was spared the need to run Keynesian-type deficits to deal with the post-1985 endaka fukyo .

But all bubbles burst. By the end of the decade, the BOJ was worried by a massive appreciation in land and stock prices. Before long, monetary tightening accompanied renewed trade friction with the US, prompting more yen appreciation and another recession. It was only in 1995-96 that the US eased its position and allowed the yen to depreciate against the dollar. But the respite was short-lived. As US pressure for a strong yen resumed, Japan's economy plunged into its second endaka fukyo of the 1990s, from which it has yet to emerge.

Successive stimulus packages failed, leaving behind a massive build-up of public debt. Fiscal stability, meanwhile, is already threatened by the growing pension and health-care costs implied by a rapidly aging population. Another asset price bubble is out of the question; the last one left most of the domestic financial system virtually insolvent. So Japan's future prospects ultimately depend on the US abandoning its strong-yen policy.

The US's policy is, in fact, economically indefensible. In a world of integrated capital markets and floating exchange rates, the trade balance between any two countries reflects the difference between their domestic investment and savings. The US has saved less than it invests for two decades, while Japan has done the reverse. Japan's bilateral trade surplus is nearly the same size as its savings in the US. As long as America borrows Japanese savings to fuel its domestic investment, a trade deficit is inevitable.

A strong yen can not prevent this. When Japan's asset-price bubble burst in 1990-91, Japanese investors pulled out of the US-leading to a credit crunch and the mild recession that torpedoed President Bush's re-election hopes in 1992. But pitifully low domestic returns on capital soon spurred Japanese investors to resume foreign lending, fueling the massive investment boom of the Clinton-era "new economy."

Japan has hardly benefited. Although Japan is now the world's largest creditor nation and the US its largest debtor, its foreign-trade and capital flows are still largely denominated in dollars. Unlike past creditor nations - Great Britain in the 19th century and the US for most of the 20th - Japanese investors have borne the exchange-rate risk involved in foreign lending. With the dollar depreciating against the yen, the returns on their foreign investments in the 1980-90s were virtually wiped out.

So pity the millions of aging Japanese who bailed out the world economy - America, in particular - and now have nothing to show for it.