Last week’s “Back to the Future Day” not only evoked a sense of nostalgia, but it also served as a reminder of other significant events marking 30th anniversaries this year, such as the Plaza Accord and the publication of an influential economics paper. Although the three appear to have little in common, but in fact they all involve Japan to varying degrees.
In the second installment of the time-travelling cult classic, released in 1989, the future Marty McFly’s supervisor was named “Ito T. Fujitsu,” which made sense back then as Japan’s economy and corporations had looked invincible at the time, on the verge of taking over the world.
John Kenneth Galbraith, a renowned economist, remarked in his 1987 book entitled History of Economics as follows:
“Japan, hitherto a prime consumer of American ideas, will become the source of economic thought for yet newer countries on the industrial scene, and in reverse flow, for the United States and Europe…The industrial world, and not least the United States, has already become deeply concerned with the economic ideas and more especially their practice in Japan, making that country and its economic life an important field of study.”
The 1985 Plaza Accord takes its name from New York City's Plaza Hotel, when the finance ministers of the U.S., the U.K. France, Japan and then West Germany, reached an agreement to depreciate the U.S. dollar against the yen. Since then, however, things have changed drastically. The yen appreciated rapidly against the dollar. At first, Japan's economy withstood the appreciation, thanks in part to the fall in oil prices, but the country's macroeconomic policy began to go astray.
Throughout the period since 1985, the overvaluation of the yen has persisted with the exception of a few years from 2006 to 2008, when Japan experienced a brief economic recovery. The nominal exchange rate has been consistently higher than the “equilibrium” exchange rate based on purchasing power parity. This has been noted by the late Professor Ronald McKinnon of Stanford University and Kenichi Ohno of the Graduate Research Institute of Policy Studies as the “ever-higher yen syndrome.” Against this background, one can see the significance of Abenomics as attempting to address the issue.
In his recent column on "The Japan Syndrome Comes to China", Jeffrey Sachs, a professor of economics at Columbia University, urges Chinese authorities to devalue its currency, the renminbi. Drawing on the Japanese example from the late 1980s, he argues that the renminbi is now overvalued relative to its slowing economy, and China should not repeat the same mistake of Japan by falling into the “ever-higher yen syndrome.”
The paper published 30 years ago by Professor Sachs and Barry Eichengreen of the University of California, Berkley, was on competitive devaluation during the Great Depression, entitled: “Exchange Rates and Economic Recovery in the 1930s.” Their argument challenged the old consensus that competitive devaluation had a detrimental effect on the economy. Instead, they stated that competitive devaluation combined with expansionary monetary policy by economies was a necessity and beneficial. So when Professor Sachs urges the China of today to adopt devaluation, he clearly has the same paper from 1985 in mind.
Can China avoid falling into the Japan syndrome? Not unlike the “golden fetter” of the Great Depression period, the “renminbi fetter” is constraining Chinese authorities’ capacity to engage in monetary policy. The overnight Shibor, Shanghai Inter Bank Offered Rate, should have gone down if monetary policy had been working, but it went up from 1% in April this year to 1.8 % in October.
Chinese policymakers must have been assiduously studying the Japan’s “ever-higher yen syndrome,” but as the old quote attributed to Otto von Bismarck goes, “Only a fool learns from his own mistakes. The wise man learns from the mistakes of others.” Also, it may take more than knowledge for China to devalue the currency. Let’s hope that China's future won't be a repeat of the mistakes from Japan's past.
