Yen and Yuan

In the years following the end of World War II, the Japanese economy witnessed tremendous growth which is often referred to as an “economic miracle”. Japan’s rapid industrialization in the post-war years embraced technological progress and Japanese industry focused on producing high-end technological equipment, innovative electronic products and most reliable automobiles. Rising economic productivity, because of technological progress, coupled with strong exports of renowned international products, such as Sony, Toyota

and Honda, among others, boosted Japan’s economic growth. Japan’s economy grew at an average annualized rate of 10

percent during the 1960s, 5 percent during the 1970s and 4 percent during the 1980s.

However, in order to boost their export related industries, the Japanese government had fixed the exchange rate between the Japanese yen and the US dollar at 360 yen to US$ 1 in 1949. But a high volume of Japanese exports to the US and Europe started causing international tensions in the 1970s. The global stagflation and oil crisis of the 1970s were causing economic woes in the US and other major developed economies in Western Europe. And because of an acute balance of payments crisis, the US had to withdraw from the gold standard and abandon the convertibility of its currency into gold in 1971.

Due to international pressure, Japan finally revalued the yen from 360 to 308 per US$ 1 in December 1971; and later, in February 1973, adopted a floating exchange rate system. However, in order to protect Japan’s industry, the Japanese government kept on intervening in the foreign exchange market and managed to keep the yen at around 250 to 300 to US$ 1. As a result, Japanese exports kept on surging — the share of exports in Japan’s gross domestic product increased from 11.7 percent in 1973 to 14.5 percent in 1984.

Flush with excess foreign

currency, the Japanese government bought US treasuries which helped keep the yields on US government bonds low.

Around that time, while Japan was enjoying economic prosperity, the US was facing economic problems. Although the US had emerged from a series of economic recessions in the 1970s and early 1980s, the artificially low exchange rate of the Japanese yen and the Deutsche mark were undercutting the competitiveness of American industry and stifling a full-fledged economic recovery. As a result, there was a lot of political pressure from the Americans on the Japanese to let the yen appreciate.

To followers of international policy issues, these events of the 1980s sound eerily familiar with what is happening now in terms of the Chinese yuan. The Chinese government, like the Japanese government in the past, has kept its currency artificially low for a number of years to promote Chinese exports. And the weak yuan has paid off handsomely to China as export-led economic growth has propelled China to the second largest economy in the world — a place which was till a few months back occupied by Japan. And like Japan in the 1970s and the 1980s, due to massive influx of foreign currency, the Chinese government has been buying US treasuries and helping to keep yields on US government bonds low. Although the US has been pressuring China for a long time to let the yuan appreciate, the current state of the US economy, with an unemployment rate in excess of 9.5 percent, has compelled US policymakers to raise their voice against a weak yuan.

During the recently held annual meeting of the World Bank and the International Monetary Fund, the major discussions revolved around China’s currency policy. Given the state of the US economy and China’s massive trade surplus with the US, Americans feel that, by keeping the yuan artificially low, China is taking away jobs from the US. But China hasn’t budged so far. Recently, Chinese President Hu Jintao said that allowing the yuan to appreciate too quickly would undermine the competitiveness of Chinese industry and cause social unrest in his country as a lot of workers were dependent on it. A look back at what happened to Japan after it caved in to US demands gives an idea about why Chinese officials won’t bow to US demands.

In the mid-1980s, due to pressure from the US government, Japan had to yield. Amid growing geopolitical tension, the governments of Japan, the UK, West Germany, France and the US signed an agreement at the Plaza Hotel in New York City on Sept. 22, 1985, whereby they decided to intervene in the foreign exchange market to weaken the US dollar against the yen and the Deutsche mark. After the signing of the Plaza accord, the US dollar weakened against the yen by over 50 percent between 1985 and 1987. However, to keep its economy moving along, the central bank of Japan reduced the interest rate to prop up domestic demand which, however, adversely created an asset price bubble in Japan in the late 1980s. After the bubble burst in the early 1990s, Japan’s economy has been perennially underperforming for the last two decades.

China, with the benefit of hindsight, has understood

that allowing the yuan to appreciate too quickly would undermine its economic performance. Moreover, China, because of the size of its population, is nowhere near Japan — when it signed the Plaza accord — in terms of per capita income and has a lot of catching up to do. Hence, it’s unlikely that there will be a

Plaza-like agreement in the coming days, and more ugly exchanges between US officials and their Chinese counterparts are likely to persist for the foreseeable future unless another viable compromise can be reached.

This article was first published in The Kathmandu Post on 25th October 2010
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