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China urged to avoid cautionary tale of Japan and the Plaza Accord in currency deal with US

Amid reports that the United States will demand that China stop devaluing its currency as part of any trade agreement, Beijing has been urged to learn from the cautionary tale of Japan, which in 1985 agreed to a currency deal which has shouldered a good portion of the blame for its economy’s disastrous “lost decade”.

The US demands that China limit the yuan’s depreciation have been compared with the Plaza Accord, under which Japan, France, Germany, the United Kingdom and the US agreed to push the value of the US dollar down against the Japanese yen and German Deutsche mark.

The five countries began selling large amounts of US dollars, leading to a significant loss in dollar value.

The intervention resulted in the Japanese yen doubling in value against the US dollar in under two and a half years.

Japan was at the time an exporting powerhouse.

Yen appreciation would have made its exports too expensive for many foreign buyers, so the Bank of Japan aggressively intervened, cutting interest rates five times, in an effort to devalue the yen and keep exports competitive.

However, low interest rates led to a boom in domestic lending.

A property bubble formed and stock market prices tripled, even as asset quality nosedived. Japan’s financial bubble inevitably burst, pushing the country into a deflationary liquidity trap from which it is still trying to escape today.

China’s modern trading relationship with the US has echoes of the US-Japan situation three decades ago.

Japan ran a large trade surplus and was blamed for US job losses. There were fears in Washington that Japan would overtake the US as the world’s largest economy.

Many of the same grievances exist today towards China.

Indeed, as well as currency intervention, snapback tariffs were also used against Japan. These are currently being considered by US trade negotiators as they attempt to thrash out a deal that would curtail China’s economic rise.

However, analysts are reluctant to make too much of the comparison.

“A lot of people are making comparisons of China’s situation with Japan’s Plaza Accord. But China is very alert about what happened to Japan and would want to avoid repeating the same mistakes,” said Gao Qi, currency strategist at Scotiabank said.

Nathan Chow, economist at DBS Bank, said that China may be reluctant to sign a new version of the Plaza Accord, since it could lead to lower interest rates, fuelling new bubbles in China’s stock and property markets, as Japan experienced in the 1990s.

“It would be difficult for Chinese authorities to manage its economic cycle if it needed to control the currency in a way that created market distortions. China may simply accept a framework of keeping the exchange value of the yuan stable without offering much operational detail,” Chow said.

Voices in the Chinese media have been looking to a more recent currency deal as a potential blueprint for a China-US currency agreement.

The US-Mexico-Canada Agreement (USMCA, the revamped North American Free Trade Agreement signed last year) contains a currency clause, which could set a precedent of future US trade agreements, according to a post by Taoran Biji, a widely regarded, government-related WeChat account

The clause demands that currencies are market-determined and that signatories avoid competitive devaluation, as a means of gaining a competitive advantage in trade.

It is the first time such a clause had been included in a major trade agreement.

China has previously signed up to to commitments at the G20 and International Monetary Fund that bar it from competitive devaluation.

However, critics claim that China has not upheld these commitments. In an interview with the Financial Times last year, US Treasury Secretary Steven Mnuchin noted that the yuan had fallen significantly over the course of 2018.

“As we look at trade issues there is no question that we want to make sure China is not doing competitive devaluations,” he said.

Arthur Kroeber, co-founder and research head at Gavekal Dragonomics, said that a currency agreement would be aimed at satisfying the demands of Mnuchin, a more dovish presence in the US administration, compared to hardliners such as US trade representative Robert Lighthizer.

“An exchange rate agreement is just a way for Beijing to collude with Trump administration doves like Stephen Mnuchin to trumpet a non-event as a big US victory,” Kroeber wrote.

Former US Federal Reserve chair Janet Yellen last week that it is “difficult and treacherous” to define when a country is manipulating its currency, warning US trade negotiators to think twice about asking China to maintain a stable yuan exchange rate.

Countries should be allowed to use monetary policy tools that would ultimately have a systematic effect on a country’s exchange rate, Yellen said.

“So we would want to be careful not to define domestic policy tools as currency manipulation,” she said.

The US Treasury has so far refrained from formally labelling China currency manipulator, ostensibly due to a lack of evidence.
Source: South China Morning Post

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