Economics of the yen and the renminbi

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SummaryIn the 1980s, the most common threat to the economic hegemony of the United States was Japan, which was feared for its growth and the competitiveness of its industry.

While many argue that China’s competitive devaluation is similar to Japan’s in the 1980s, the two couldn’t be more different

In the 1980s, the most common threat to the economic hegemony of the United States was Japan, which was feared for its growth and the competitiveness of its industry. There was an outpouring of research evaluating the Japanese threat. The dollar was deemed too strong, and the yen and the Deutsche mark too weak. Robert Lawrence’s 1984 book Can America Compete? was a must-read. In 1985 came the G-5 Plaza Agreement, which increased the value of the yen more than 100% in a matter of a few years. At its peak, in 1991, Japan’s income was 43% of US GDP. Japan’s growth slowed to a trickle thereafter, and starring in the mid-1990s begins the story of Japan’s lost decades …

The situation with China could not be more different. It is very likely that the renminbi is more undervalued by an order of magnitude than at the peak of the undervaluation of the yen or the Deutsche mark in the 1980s. China’s current account surplus is also significantly higher than that of either Germany or Japan at the peak of their respective experiments with mercantilism. Most important, China’s growth rate, relative to its own trend, is also significantly higher. Indeed, China hit its peak growth rate just a few years ago. In comparison with an average overvaluation of the yen by 9% during 1976-85, and an average overvaluation of the Deutsche mark by 20% during the same years, China has had an average undervaluation of 41% during the last 10 years …

Déjà vu?

It is likely that Japan’s growth rate collapsed in part because of the Plaza Agreement of 1985, which in three short years catapulted the yen from an average exchange rate of 240 yen to double that level (in real terms; the nominal exchange rate was cut in half). Will a quick revaluation of the renminbi lead to a similar implosion in China’s growth? And can the world afford to lose its major growth engine in the face of slow growth in the advanced economies?

Interestingly, according to my measure, the yen was not really so under-valued at the time of the Plaza Agreement in 1985. It was undervalued by only 4.7% compared to an undervaluation of 31% before the dollar float in 1971 (when the exchange rate was 360 yen to

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