A few days ago, I stumbled across an influential tome written two decades earlier by Taggart Murphy, a journalist-cum-banker, called The Weight of the Yen. It is wryly relevant today – though not in the way Murphy might have thought.
When Murphy wrote his book, what was worrying many American policymakers – and some Japanese – was the weakness of the yen; most notably, during the 1970s and early 1980s the yen had been kept artificially low by government controls, running at around Y250-Y300 to the dollar. As a result, the Japanese export machine boomed, undercutting American industry; and Japanese investors gobbled up American debt, keeping US Treasury yields artificially low.
Or, as Murphy wrote: “The causes of the imbalances were twofold: first the US Federal Deficit, which the Reagan Revolution had structurally embedded into the US body politic; and second the Japanese ‘development state’ system of national leverage, centralised credit allocation and credit risk socialisation.”
These days, of course, the story has moved on – at least as far as Japan is concerned. This week the Tokyo government has been busily intervening to weaken its excessively strong currency, which hit Y82.88 earlier in the week. And American pundits are no longer fretting about “unfair” Japanese exports or bond purchases; instead, the country has largely moved off the US political radar screen.
However, if you replace the word “Japan” with the word “China”, Murphy’s book creates a powerful sense of déjà vu. After all, these days it is Beijing which is primarily using a weak currency and “centralised credit allocation” – to use Murphy’s words – to boost an export machine, even as it gobbles up US Treasury bonds. Meanwhile, American politicians are now calling for a major revaluation of the Chinese currency, comparable to the so-called Plaza deal that was struck between five leading western countries in 1985 to revalue the yen.
Will this pressure actually work? Right now, as my colleague Alan Beattie reports, the chance of a new Chinese-style Plaza deal seems unlikely. But as the currency tussle intensifies, it is worth taking a closer look at some of the lessons from the period that were covered in Murphy’s book. Back in 1985, when the deal was first struck to strengthen the yen, many American observers initially considered it a success. For in the late 1980s, the currency moved towards the Y150 level, where it stayed for several years.
But – ironically – this “success” did not deliver much lasting stability at all. On the contrary, as the purchasing power of the Japanese currency swelled, Japanese institutions continued to gobble up overseas assets (including Treasury bonds). Meanwhile, the Bank of Japan slashed rates to ward off an export decline and stoke up more domestic demand. That paved the way for a crazy bubble, followed by a bust, and more currency instability in subsequent years. Or, as Murphy adds: “Changing the units of account had not the slightest chance of dealing with these fundamentals [distortions]. But they made for a more unstable world.”
Now, given that, it might seem tempting in retrospect to conclude that the Plaza Accord was a bad idea. And, unsurprisingly, that is exactly what some Chinese policymakers now say. However, in reality, the story is more nuanced. For perhaps the biggest reason for Japan’s boom and bust – and wider instability – was not simply what happened in the Plaza deal; instead the crucial period is what did (or did not) happen in the decades before.
The issue at stake revolves around Japan’s “development state”. In the immediate years after the second world war, capital was so scarce that it seemed to make sense for Japan to use centralised credit allocation and capital controls to channel its funds to industry. But by the mid 1970s its industry had rebounded so fast that the country had “outgrown” its need for this bank-centred system – just like a child might outgrow a pair of shoes.
In retrospect that suggests the Japanese should have removed controls earlier; in practice, though, Japan resisted reform. Hence by the 1980s Japan was plagued with distortions – currency undervaluation was just one. And that, in turn, made it hard to implement any smooth adjustment.
Can the Chinese avoid these mistakes? They certainly claim to be trying. After all, Beijing is now implementing a programme of financial reform that is intended to help the Chinese financial system to slowly “grow up”, away from a developmental model. But to my mind this pace of liberalisation – and currency adjustment – still seems dangerously slow, given the speed at which China is growing.
Perhaps it is time to translate The Weight of the Yen into Chinese; if nothing else, it is a potent lesson of the risks that can be created both by rapid revaluation – and by refusing to reform at all.
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