Mar 18, 2019 08:35 PM

Caixin View: The Yuan Won’t Follow the Yen’s Example

(Beijing) — In 1985 the U.S., Japan, the U.K., France and West Germany agreed to coordinate in order to devalue the dollar, in part to help the U.S. reduce its large trade deficit. After this agreement — known as the Plaza Accord — was put into effect, the Japanese yen appreciated sharply against the dollar (as did other major currencies). To limit the negative effect this would have on exports, the Japanese central bank loosened monetary policy. An asset bubble followed, and after it burst in the early 1990s, Japan’s “Lost Decade” of economic stagnation began.

Of course, the actual effects of the Plaza Accord, and its links to the sudden end of the Japanese economic miracle, are far more complex than this short summary might imply. But to some concerned observers of the U.S.-China trade negotiations, both in domestic media and the markets, the parallels between U.S.-Japan trade tensions of the 1980s and present frictions between the world’s two largest economies are clear — and there are worries that a new Plaza Accord could be forced upon China, perhaps with similar consequences.

We think this is very unlikely. After plummeting last year, the yuan has appreciated somewhat in 2019 — it closed Monday at just above 6.71 per-dollar— largely on the back of positive signals from trade negotiations and an increased influx of foreign capital. But there’s little chance of it strengthening further to anywhere near the degree that the yen did in the 1980s. That’s because:

• China’s economic growth is slowing, with the government work report targeting 6% to 6.5% growth in 2019; a flexible target is further evidence that the government is becoming more tolerant of lower growth rates.

• Though policymakers have been clear that they won’t flood the economy with a 2009-style stimulus, monetary policy is becoming looser, which will also put downward pressure on the yuan. Li said that China will continue to pursue a “prudent” monetary policy this year, omitting the word “neutral” — which he had mentioned in last year’s work report. A benchmark interest rate cut this year, which would be the first since 2015, is looking more likely — a strengthening yuan, and a dovish U.S. Federal Reserve ceasing its cycle of rate hikes, have created a window of opportunity for this to occur. Central bank Governor Yi Gang has also said that there is still room for a reserve requirement ratio cut, although this has diminished after a series of such cuts last year.

Under these conditions, China would have to struggle mightily to strengthen its currency against the dollar to a large degree, and as we have argued before, it has few good reasons to do so. Treasury Secretary Steven Mnuchin has said that China and the U.S. have reached “one of the strongest agreements ever on currency.” We don’t know what this agreement may be. But we don’t think that Japan’s economic trajectory in the 1980s and 1990s will be particularly helpful to understand whatever happens next in the China-U.S. trade war saga. And for those who are still tempted to make parallels, it’s worth pointing out that the Plaza Accord did little to fix the Japan-U.S. trade imbalance. In 1985, the U.S. ran a $46 billion deficit in trade in goods with Japan, according to the U.S. Department of Commerce. Since then the annual deficit has never dipped below $41 billion and has usually been much higher — in 2018, it was $67 billion.

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