What the Yuan can Learn from the Yen

The renminbi exchange rate has attracted significant attention from both market participants and government officials. Assessing how the renminbi’s sharp appreciation will impact the economy of the People’s Republic of China remains a heated discussion point among experts. Here history may offer us some insights.

Japan’s economy underwent two periods of sharp yen appreciation subsequent to World War II. The first period occurred when President Nixon suspended the convertibility of the dollar to gold in 1971. This shock led major currencies, including the Japanese yen, to shift from fixed rate systems to floating rate systems. The yen then sharply appreciated from 360 to 260, which lasted for several years. The second big yen appreciation coincided with the “Plaza Accord” of 1985. Radical adjustments were made for major currencies vis-a-vis the US dollar. Between 1985 and 1987 the Japanese yen increased from 240 to 120.

Interestingly, both periods were marked by high economic growth in the United States coupled with a subsequent deterioration of US trade and fiscal balances. Concurrently, Japan was enjoying export-driven economic growth and a significant trade surplus. Political and geographical considerations were also important. During these two yen appreciations, the United States was involved in the Viet Nam War and an intensifying Cold War. These were times of increased US military expenditures which aggravated the US fiscal balance. Of course, the situation in Iraq is placing similar burdens on the US economy right now.

Are there any lessons we can draw from the yen’s experiences then? Japan’s primary concern during sharp appreciations was the impact of the yen on the export-driven manufacturing industries and the consequent economic slowdown. To address these worries, Japan attempted to maintain a pegged rate system as well as minimize further appreciation by stimulating domestic demand. Excessive domestic adjustments were made to maintain the external equilibrium. Monetary policy appeared to lose its free hand. And notably, Japan’s economy suffered from hyperinflation or “economic bubbles” following both appreciations.

Another point to remember is that the yen’s appreciation in both periods triggered large-scale and far-reaching changes in Japan’s industrial structure. In the 1970s, assembly-type machinery industries such as automobile and electronic appliances became mainstream. They replaced traditional heavy steel and chemical industries. Following the yen’s sharp appreciation in the1980s, more high value-added industries began growing domestically. Manufacturing companies started operations overseas by using FDI.

We can see there is a trade-off between adhering to a fixed rate system and maintaining an independent monetary policy under free international capital transactions. In the PRC the liberalization of capital actions is not yet complete. And nuanced options other than a pure pegged system or a perfect floating system do exist.

The People’s Republic of China always needs to keep in mind who might become the eventual winners and losers from currency fluctuation as the yen model has shown that impacts are long-range and far-reaching.

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1. Bala Bhaskaran
   (posted 21 April 2008 / 11:12:39 AM)
   
   The brief paper offers insight into the dynamics of currency apreciation and its impact on the economy. Can it not give references of research papers and case studies on the same subject? That will be a lot more useful to the researcher.