Tag Archives: yen

Yuan-Yen Direct

Direct trading between the Chinese and Japanese currencies starts Friday, cutting out the dollar as an intermediary. Rates will be posted in Tokyo and Shanghai, with China’s monetary authorities allowing a 3% daily trading band for the yuan against the yen (the dollar gets a mere 1% band).

And so Beijing takes yet another step along the long road to the internationalization of the yuan. How long before the won joins in, a likely next step given the plans for a free trade agreement between China, Japan and South Korea?

There is no particular reason for trade not involving the U.S. to be exposed to the potential volatility of the dollar. Direct currency settlement should increase yuan settlement of China’s imports and exports, as it lessens the currency risk for Japanese and South Korean buyers of goods denominated in yuan. The same idea is behind plans for an agreement between China and its fellow Brics, Brazil, Russia, India and South Africa, to make loans in their own currencies to facilitate trade. The five Brics plus Japan and South Korea account for about 30% of world GDP, compared to 45% for the U.S., the U.K. and the Eurozone.

Greater use of the yuan in trade could eventually grow into full convertibility of the currency. Before then, though, there will need to be a loosening of China’s capital controls and more opening of China’s capital markets. Both represent a greater political challenge than expanding trade finance. Opponents of reform have been able to argue that China’s national interest has been well served by cross-border capital controls and the ring-fencing of the country’s financial system. Only beyond that still distant horizon lies reserve currency status.

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China As Japan 1985 Redux, Or Not

The IMF’s latest World Economic Outlook left its projections for China’s GDP growth for this year and next unchanged at 9.6% and 9.5% respectively, a slight slowdown from the 9.8% by which, the IMF estimates, the economy grew in 2010 and ahead of Beijing’s own forecasts. A set of traffic light warnings on whether the economy is overheating are mostly at amber.

The Outlook also devotes a sidebar to the lessons of Japan’s bubble in the 1980s and the effects of the rapid appreciation of the yen, forced on Tokyo by the Plaza Accord of 1985. The piece starts by saying that “some argue that this is a cautionary tale, exemplifying the dangers of reorienting economies through currency appreciation” and sourcing the some to the People’s Daily, so it is pretty clear where the lesson is directed. Not that that is any surprise given that the IMF has long been a critic of China’s slow appreciation of the yuan, a process being tightly managed by Beijing because of the risk of social dislocation.

The IMF authors’ central argument is pretty clear: the rapid appreciation of the yen wasn’t the cause of the Japan’s “lost decades”. The sequence of events is unquestioned. The yen’s rapid appreciation stopped Japan’s export and GDP growth in its tracks; the government responded with a big stimulus package; an asset bubble was inflated that went pop in 1990 and the economy has essentially been becalmed since.

What is put at question is whether the stimulus was excessive (yes, say the IMF’s authors) and whether it alone was responsible for the bubble (no, they say; financial deregulation allowing a rapid expansion of bank credit for real estate investment and tardiness in reining it in were also to blame; two factors compounded first by the overleveraging of Japan’s banks that were at the heart of keiretsu, or groups of closely affiliated companies, and then by the political constraints on authorities forcing the keiretsu to restructure and write off their debts which didn’t happen for a decade, allowing time for further policy missteps and external shocks). In short,

The conditions facing Japan were in many ways unique, and the bad post-Plaza outcome was due largely to a credit bubble that developed after exceptional policy stimulus was combined with financial sector deregulation. When the bubble burst, exposing underlying vulnerabilities, political economy constraints meant that restructuring progressed too slowly.

The IMF says circumstances in China today are different from those in Japan in the 1980s so past won’t be prologue. First, China’s households, corporations, and government aren’t as overborrowed as were Japan’s pre-bubble. Second, China has more room to move up the export quality ladder than Japan did, which will help offset the impact on growth of currency appreciation (though risks labor dislocation in low-end export manufacturing), and third, Japan had a floating exchange rate regime in the 1980s, whereas China has a managed exchange rate supported by vast foreign currency reserves and restrictions on capital inflows. “This difference in currency regimes should help China avoid the sharp appreciation observed in Japan,” says the IMF. Which is exactly Beijing’s point.

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Beijing Heeds The Lessons Of Japan’s Yen Revaluation

As G-20 finance ministers and central bankers meet in Seoul to call a verbal truce at least in the currency wars, Bloomberg has a piece noting that China has taken note of what happened to Japan after the 1985 Plaza Accord led to the rapid appreciation of the yen against the dollar.

A short history lesson for younger readers: Following the accord between what was then the G-5 to depreciate the dollar against the yen and the mark, the dollar fell by 51% against the yen between 1985 to 1987. Japan’s exports shrank, unemployment rose, cracking the system of lifetime employment at the large conglomerates, and the economy slowed dramatically — the endaka fukyo, high-yen recession. The cutting of interest rates to get the economy going again led to the asset bubbles which, after they inevitably went pop, left the country mired in debt, which in turn has left the Japanese economy becalmed in the still waters of recession and deflation ever since.

Now Japan made policy mistakes and had a political and social system designed to absorb external shocks rather than effect change when change was needed, so the analogy only goes so far, but Beijing doesn’t want to go anywhere near there in the first place. Hence its determination to let its own currency appreciate only gradually.

There are two other lessons from Japan’s experience in the 1980s that won’t have escaped the notice of China’s leaders. First, it was Japan’s huge current account surpluses that had given it the global buying power in the 1980’s that made the country “No 1” and raised a scare among developed nations, particularly the U.S., that Japan was taking over the world and would eclipse the U.S as the world’s leading economy. When the current account surpluses disappeared, Japan’s emerging clout on the world stage evaporated with it. Second, what happened to Japan’s economy after the Plaza Accord led eventually to the long-ruling Liberal Democratic Party lose its monopoly grip on power.

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