China and the Looming Currency Showdown in Seoul

The currency war is heating up, and battle lines are being drawn. The U.S. Dollar Index is near an all-time low, and the Federal Reserve is preparing another round of quantitative easing, flooding the world with even more greenbacks. Japan has looked on in alarm as the rise in the value of the yen is impacting Japanese exports and threatens to choke off any hope of economic recovery. And everyone is looking at China and the value of the yuan, and preparing for an expected currency showdown at the November G20 meeting in Seoul.

Where do the Chinese stand? If you want to understand China’s position with respect to its currency, I believe that two events in modern economic history provide useful perspective. The first is the 1997 Asian Crisis and the second is the Plaza Accord of 1985.

If you had asked me at the beginning of 1997 when the renminbi would become fully convertible, I would have predicted that this would occur around the turn of the century. All of the signs pointed in that direction and it seemed like the next logical step in China’s economic development. And then, in July, 1997, a financial tsunami hit Asia and one Asian nation after another teetered on collapse. This event is known as the 1997 Asian Crisis.

The crisis started in Thailand with the collapse of the Thai baht, Thailand’s currency, caused by the government’s decision cut the baht’s peg to the US dollar and to float the currency. This decision came after the Thai government had exhausted its efforts to support the baht in the face of severe capital outflows due to over extension that was in part real estate driven. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.

Although China was largely unaffected by the Asian Crisis, it looked on as large pools of speculative “hot money” provided by George Soros and other hedge fund managers flowed in and out of one Asian country after another, leaving devastation in its wake. I believe that right then and there, that the Chinese government decided that it had better not float the renminbi until China’s capital markets were more stable and it could withstand such large capital inflows and outflows. As a result, no one today expects the renminbi to become fully convertible anytime soon.

In September, 1985, a group of international financial heavyweights gathered at the Plaza Hotel on 59th Street in New York and hammered out a currency agreement. At this historic meeting, the finance ministers of France, West Germany, Japan, the United States, and the United Kingdom signed the Plaza Accord in which they all agreed to depreciate the U.S. dollar in relation to the Japanese yen and German deutschemark by intervening in currency markets. The reason for the action was to reduce the U.S. current account deficit, which had reached 3.5 percent of the GDP, and to help the U.S. economy to emerge from a serious recession that began in the early 1980s. Sound familiar?

In the two years following the Plaza Accord, the exchange value of the dollar versus the yen declined by 51 percent. The recessionary effects of the strengthened yen created an incentive in Japan’s export-dependent economy for the expansionary monetary policies that led to the Japanese asset price bubble of the late 1980s, which in turn ended in a serious recession and Japan’s so-called “Lost Decade.” Twenty-five years later, the dollar-yen exchange rate has sunk nearly 70 percent, and yet the United States has the same bilateral deficit with Japan today as it had in 1985.

Although China was not the superpower it is today at the time, it nonetheless learned from Japan’s experience. Therefore, when President George W. Bush and Japan tried to pressure China to float (revalue) its currency in 1993, Jiang Ruiping, Chairman of the Department of International Economics of the Foreign Affairs College in Beijing responded with a commentary that was published in the official People’s Daily.

The Executive Intelligence Review summarized Professor Jiang’s article as follows:

“The U.S. forced the Japanese yen to revalue,” in order to artificially eliminate the huge U.S. financial and trade deficits with Japan. The Ronald Reagan Administration called a G-7 finance ministers’ meeting, held at the Plaza Hotel, which “agreed” to force the currencies of especially Japan and Germany, to rise against the dollar. The yen doubled in value against the dollar in just two and a half years.

Postwar Japanese economic growth, “which depended heavily on foreign resources,” was thrown into a “yen revaluation depression,” wrote Professor Jiang. Tokyo resorted to its “zero-interest-rate” money printing, and set off that country’s huge real estate and stock market bubbles; when they crashed, Japan was plunged into its persistent economic/financial crisis. Japan’s drastic currency manipulations in 1997-98, which this time cut the yen’s value by almost 55%, played a big role bringing about the Asian financial crisis. This is the bitter pill that Tokyo, trying “to be hand in glove with the U.S.,” has been attempting to make China swallow.

When the finance ministers from the G20 nations gather in Seoul in November, they will encounter a Chinese delegation that understands this history, and is determined not to repeat it.

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