U.S. Treasury Secretary Paul O'Neill said Wednesday in Tokyo that he is optimistic about prospects for Japanese economic reform. He also said the nation's prolonged economic slump is starting to drag on the global economy.

Secretary O'Neill said at a news conference in Tokyo that Japan has performed far below its potential for the past decade. The Japanese economy is in a recession, as it has been for much of the past 11 years, and the country faces a banking crisis.

However, he says the world's second largest economy could rebound, because the country has a diligent work force and its best firms, such as car maker Toyota, are highly competitive around the world. "I have developed a conviction about Japan that Japan can accomplish whatever it wants. The only question is what does Japan want?," secretary O'Neill said.

The secretary, who spoke after a Tokyo conference on Afghan reconstruction, says a weak yen cannot revive Japan's troubled economy. The yen has fallen by about 12 percent against the dollar since September, and it is down more than two percent since the end of December.

Some Japanese policymakers have indicated they want a cheaper yen. It helps the economy by making Japanese exports less expensive for overseas buyers.

Mr. O'Neill also urges Japan to quickly resolve the problem of bad bank loans an issue he and other U.S. officials have frequently mentioned in recent months.

He also warns of potential capital flight from Japan, where interest rates are at about zero. "Over any reasonable period of time, the capital that is invested in Japan has to produce a competitive rate of return, otherwise the money will go away," secretary O'Neill said.

Regarding the U.S. economy, Mr. O'Neill says the conditions for economic recovery are now in place. He notes that there are renewed hopes for congressional approval of a stimulus package, to more quickly lift the United States out of its own recession, now nearly a year old.