What China Wants to Avoid in Trade Talks: Becoming the Next Japan
History doesn’t repeat, but it rhymes, as the cliché goes. But sometimes the historical rhymes are as strained as those in some bad rap lyrics.
According to the Chinese press, as part of the ongoing U.S.-China trade talks, the American side may push a new Plaza Accord to prevent a depreciation of China’s currency. This should be a warning to China, the articles assert, because Japan’s “three lost decades” can be blamed on the 1985 deal, struck at the iconic hotel overlooking Central Park in New York City. The Plaza pact lowered the U.S. dollar’s value and sharply boosted the main U.S. trading partners’ currencies, notably the Japanese yen and the West German mark.
The parallels between now and the 1980s are apparent, the Chinese state-controlled media argue. Back then, the U.S. was upset about its burgeoning trade deficit and feared that Japan, in particular, would surpass the West with its superior efficiency and technology. By forcing Japan to raise the value of the yen, its competitiveness would be hampered and its national ascendancy would be thwarted, according to the narrative.
Japan acceded by doubling the yen’s value, but sought to cushion the effect of the uncompetitive exchange rate on the domestic economy by sharply easing monetary policy. Instead, the monetary stimulus inflated a massive asset bubble, sending real estate and stock prices soaring. The bubble burst, and the Nikkei 225-stock average now sits around 21,000, a little more than half its peak reached in December 1989. (In comparison, 25 years after the 1929 Crash on Wall Street, the Dow Jones Industrial Average had recovered to its past high.)
The lesson of Japan’s experience is one that China must heed, according to the articles. China must not give in to U.S. pressure to limit its currency flexibility, something supposedly being pushed “by U.S. trade negotiators as they attempt to thrash out a deal that would curtail China’s economic rise,” as one of the articles asserts.
The economic and monetary backdrops now are vastly different than those in effect when the Plaza Accord was agreed to in 1985. Still, it is worthwhile to review the assertions in the Chinese press (which, needless to say, doesn’t publish anything that doesn’t conform to the Communist Party’s views) that Beijing must resist U.S. efforts to impose a Plaza Accord 2.0, if only because the notion has gained widespread acceptance there.
In 1985, during the second Reagan administration, the Treasury Department, led by James A. Baker III, sought to correct the dollar’s then-extreme overvaluation. The tight-money policies of the Federal Reserve, headed by Paul Volcker, along with the Reagan tax cuts, had made the U.S. a magnet for money around the world, which sent the greenback soaring. At their peak, when it was “Morning in America”—the campaign slogan that figured in the Gipper’s landslide re-election—long-term Treasury bonds offered a real yield over rapidly falling inflation of nearly 1,000 basis points (10 percentage points) in 1984. (In comparison, the real yield on 30-year Treasury inflation-protected securities on Friday was only 93 basis points.)
The agreement announced at the Plaza one Sunday in September 1985 held that an “orderly appreciation of the main nondollar currencies is desirable” to correct trade imbalances. Japan and European countries had to keep their interest rates high to compete with the U.S. (they blamed this on America’s burgeoning federal budget deficit) or else risk a bigger drop in their currencies, which could spark inflation, then the main global economic problem. In practical terms, the weaker dollar allowed the U.S. and the other industrialized nations to lower interest rates and follow stimulative policies.
For Japan, that meant a near doubling in the yen’s value by late 1988, compared with its level when the Plaza Accord was struck three years earlier. To counter this, the Japanese pursued super-easy domestic policies. According to an estimate by the International Monetary Fund, Japanese interest rates were 400 basis points lower than they should have been, based on economic fundamentals such as inflation and growth. The result was the legendary bubble in Tokyo real estate and the parabolic rise in Japanese share prices.
Did the bursting of Japan’s asset bubble result in three lost decades of slow growth and deflation, as the Beijing view holds? Unlike the U.S. following the 2008 financial crisis, Japan was slow to recognize losses in its banks, while there was political opposition to bailouts. There were other blunders, such as tightening fiscal policy in 1997, which short-circuited a recovery. Finally, Japan was hurt by the 1997-98 Asian financial crisis.
Does China face a similar risk if Beijing’s ability to allow a lower yuan is curbed as part of trade talks, as the Chinese media contend?
The differences between then and now are substantial. Japan had a floating yen, while China permits only limited, controlled moves in its currency. China also has vast foreign-exchange reserves, including $1.1 trillion stashed in U.S. Treasuries, and curbs on capital movements. As I’ve written, Beijing is unlikely to use its weapons—including dumping Treasuries—to drive the yuan sharply lower.
EDITOR'S CHOICE
Finally, there is no prospect that Beijing would nearly double the value of its currency, which would put the yuan at about 3.5 to the dollar, from 6.92 late in the week, as Tokyo did with the yen following the Plaza Accord. Conversely, seven-to-the-dollar marks a line in the sand for Chinese monetary authorities, who want a stable yuan to enhance its international use. Beijing may permit a depreciation of its currency, but not a destabilizing one. U.S. Treasury data also show that China has been reducing its holdings of U.S. securities, which implies that Beijing is doing so to slow the yuan’s decline.
The Chinese media’s arguments appear aimed more at stoking nationalist feelings than in providing a valid historical context for the trade dispute with the U.S., which President Donald Trump this past week called a “little squabble.”
Indeed, the U.S. now seems more focused on bigger matters, such as security and spying, than seeking an adjustment in trade with China. That was apparent in the curbs announced on Chinese telecommunications giant Huawei Technologies, both in selling products in the U.S. and buying them from U.S. suppliers. Bringing up the Plaza Accord is just so 1980s.
Trade news dominated the markets, but the impact varied, depending on the market. Stocks plunged at the beginning of the week on news of China’s retaliation to the ratcheting up of tariffs by the Trump administration, but clawed back most of their losses to end just a bit below historic highs. Bonds, meanwhile, rallied on perceptions that trade frictions would slow the economy and force the Fed to lower interest rates to stave off a recession. Clearly, there was a divide between the glass-half-full equity types and their chronically dysthymic debt counterparts.
The aforementioned restrictions on Huawei marked a new turn in the trade wars, which heretofore were primarily concentrated on tit-for-tat tariffs that sought to redress imbalances between the U.S. and its trading partners. But it became clearer that China was the main target of Washington’s aim, as if that weren’t previously apparent.
The U.S. delayed imposition of tariffs on automobile imports by six months, and it and Canada agreed to drop steel tariffs to pave the way for the widely anticipated approval of USMCA (the U.S.-Mexico-Canada pact) to succeed Nafta.
Despite the clear impediment to near-term economic growth and the stock market, institutional investors appear to support the Trump administration’s trade policy. The CEO of Strategas Research Partners, Jason DeSena Trennert, reports from his institutional clients in Boston (“hardly Trump country”) that “there was a bipartisan feeling that standing up to China was a fight worth having to protect the national security and economic interests of the United States.” China, meanwhile, may have miscalculated in thinking that the partisan divisions within the U.S. would keep the nation from presenting a united front in the trade war.
Even so, investors battered semiconductor stocks, especially those vulnerable to restrictions on Huawei and other Chinese tech companies. They also pummeled the likes of Deere (ticker: DE), whose farmer customers are on the front lines of the trade conflict. Better positioned are companies such as Cisco Systems (CSCO), which have tactically managed around tariffs.
The fixed-income market, meanwhile, focused on the economic drag being exerted by the trade frictions.
Yields on Treasuries fell to the lowest levels in over a year, while the federal-funds futures market placed the odds of a Fed interest rate cut as soon as September at nearly even money. Most Fed watchers averred, suggesting that the central bank’s interest-rate policy would remain on hold this year and into 2020.
To quote the biggest hit of Doris Day, who died this past week at the age of 97, whatever will be, will be. Rarely has the future been less certain, which is reflected in the divergence between the stock and bond markets.
Trade concerns are also exerting a weight on consumers’ psyches. While the University of Michigan’s gauge of consumer confidence hit a 15-year high in its preliminary May reading, Bank of America Merrill Lynch’s tracking, done after the recent tariff tiff erupted, showed more concerns.
On Main Street, lower-income consumers still feel the pinch from the recent federal government shutdown, while better-heeled ones are worried about the stock market’s impact on their pocketbooks.
Que será, será.
