China and Japan: A Comparison that Falls Flat
(Caixin Online) At first glance, China's current economic situation looks remarkably similar to Japan's in the late 1980s and early '90s. As Japan in the past, China now faces mounting pressure to let its currency appreciate at a time when real estate prices are soaring.
But will China see a prolonged economic crisis similar to Japan's "lost decade?" Personally, I think such a scenario can be avoided. I think timely and accurate reform adjustments can keep China from stumbling in Japan's footsteps.
In the 1990s, Japan's leaders lost policymaking flexibility. As a result, they were unable to appreciate the country's currency and raise interest rates through a coordinated effort. This, in the end, led to the formation and bursting of an asset bubble.
China's situation is much different. China has flexibility in its exchange rate policy and has never promised western countries that it would let the yuan drastically appreciate. As a result, we can effectively adopt a "cocktail therapy" policy for China's yuan exchange rate. So as the yuan gradually appreciates in small increments, interest rates also will be correspondingly increased. China's current low interest rates give the central bank sufficient room to do this.
A one-off, sharp appreciation of the yuan would harm the real economy and put the country on the same path that Japan once walked. Moreover, any substantial appreciation of the yuan without a corresponding rise in interest rates would cause a significant amount of hot money to flow into the country.
Matching a rise in interest rates with an appreciating yuan would achieve more comprehensive policy results. An appreciation of the yuan would inevitably be beneficial to the stock market, especially real estate and aviation stocks. Higher interest rates at this point would to a certain extent cool any overheating in the stock and real estate markets, and prevent an asset bubble.
This kind of policy action also would be beneficial for popping the bubble in international commodity prices. China's tight monetary policy started a domino effect in global markets. Each time this year that China's central authorities raised the required reserve ratio for banks, international prices for major commodities such as oil and copper immediately fell to varying degrees.
Decreases in international commodity prices will also further reduce market expectations for inflation. Market expectations of inflation in the United States have fallen, but even after Chinese authorities twice raised the required reserve ratio for banks, yields on U.S. Treasury securities did not witness a significant rise, as they did last December. China holds more than US$ 1 trillion in U.S. debt and agency bonds, which can help ensure the value of China's foreign exchange reserves.
There is another concern in the market that a yuan appreciation would lead to a real estate bubble similar to what occurred in Japan years ago. Today's China and the Japan of the 1980s and '90s are similar in that they both were and are facing a shifting demographic structure. Home buying started to decline in Japan around 1990. Similarly, according to estimates, home buying in China will start falling around 2015.
Drawing lessons from Japan's mistakes, timely adjustments to the exchange rate coupled with corresponding land and household registration system reforms can help further promote the process of urbanization. This way, even when 2015 arrives, China will be unlikely to experience the kind of asset bubble burst Japan saw in the 1990s.
Although real estate prices have soared in recent years, China is not allowing a bubble to form. Rather, it's using gradual appreciation of the yuan coupled with interest rate hikes to prevent potential trouble.
Many people who warn about "drawing lessons from Japan's mistakes" as a basis for opposing appreciation of the yuan think China's situation now is the same as Japan's was in the 1990s. Like China, Japan faced a huge trade surplus. But even after the yen appreciated, the surplus did not decline significantly.
A key advantage for Japan was that it had global brands. Even after losing its competitive advantage in labor, it could still rely on name brands to maintain a trade surplus.
China, however, has few global brands. Many products made in China are highly substitutable. So as soon as the country loses its cost advantage, its trade surplus will begin to decline.
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