“The new mercantilism”

Now it´s China´s turn to be badgered by the US. David Levey sends us three links (here, here and here) to related pieces. Barring his “fixed exchange rate/currency board” quirk, I agree with Steve Hank´s take:

The United States has a long history of waging currency wars in Asia. We all know the sad case of Japan. The U.S. claimed that unfair Japanese trading practices were behind the ballooning U.S. bilateral trade deficit.

To correct the so-called problem, the U.S. demanded that Japan adopt an ever-appreciating yen policy. The Japanese complied and the yen appreciated against the greenback, from 360 in 1971 to 80 in 1995 (and 77, today). But this didn’t close the U.S. trade deficit with Japan. Indeed, Japan’s contribution to the U.S. trade deficit reached almost 60 percent in 1991. And, if that wasn’t enough, the yen’s appreciation pushed Japan’s economy into a deflationary quagmire.

That´s quite true and almost unbelievable. The chart shows the exchange rate to the dollar of the German Mark and the Yen between 1980 and 1987, a period during which the dollar first appreciated against all currencies, except, you guessed, the yen and than depreciated against the same currencies. On the down leg it depreciated against the yen too!

In 1985/87, the people at the Japanese Ministry of Finance and the BoJ had to confront the problem of stimulating the economy. Faced with a dramatic appreciation of the yen that was directly responsible for the strong reduction in economic growth, interest rates were brought down to historically low levels and money growth increased sharply.

Asset prices (stocks and real estate) took off and the exchange rate at least stopped appreciating. As commented by an anonymous BoJ employee in 1988: “Our intention was first to give a push on real estate and stock prices. With those markets on the rise, the export industries would find ways to adapt to an expansion determined by the domestic market. The wealth effect from higher asset prices would foster consumption growth and then investment. In this way, an expansionary monetary policy would jumpstart economic growth”.

It did. Growth went up to 6% in 1988 and was around 5% in both 1989 and 1990. But inflation went up too, from -1% in 1987 to 3% in 1989-90.  The BoE “panicked” (even though at 3% inflation was not much different from what it had been in 1982-85). Interest rates were quickly brought up from 2.5% where they had stayed between 1987 and mid 1989 to 6% in late 1990. Asset prices tanked and Japan´s “lost decades” began.

Steve Hanks again:

Let’s hope China ignores U.S. demands for an ever-appreciating yuan. China’s compliance would do little more than attract massive hot money flows into the country and destabilize its economy. This would be bad news for the world economy’s main engine of growth.

Yes, let´s!

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