Thought I'd elaborate more on your question about the Japanese asset price bubble of the early 90s.
You made a point about Japan. Is there any possible relationship between japan's currency manipulation and the apparently unlinked "lost decade"?
A lot of people think ending manipulation was the main factor, through both direct and indirect lines of causality. The Plaza Accord (mentioned in the last post) was meant to pull Germany, France, and other countries out of a mid-80s recession by depreciating the dollar and appreciating the yen; America and Japan were both having strong growth at this time and were willing to sacrifice a bit of it to help out Western Europe. Rebalancing trade in this way did accomplish this. At the same time it lead to appreciation of the yen, more Japanese investment seeking domestic assets, and a disruption of Japanese export production.
All this was enough of an adverse shock to the economy already. But the government overreaction made it even worse. Expansionary fiscal and monetary policy (high deficits with mere 2% interest rates) were enacted on what turned to be the mistaken belief that strong stimulus was needed to hold up the economy. This may have just blew the bubble up even bigger. Thus central bank policy is often blamed, but it may have only acted in response to the appreciation shocks. When the Bank of Japan realized its mistake and began to hike rates it had little impact, and its failure to lower rates back down quickly after the following recession, even in the face of deflation, had terrible consequences for real interest rates.
See how complicated this **** is to make cause effect narratives about?Financial deregulation had also been going on in the country since 1985. It's clear from the historical record that removing prudential regulation over the financial sector will usually lead to a financial crisis as the game changes; newly-freed banks begin lending recklessly until going out of business, clearing the way for new firms more adapted to the novel regulatory environment. To cite a few examples, it's thought that the Swedish recession of 1990 was largely due to financial deregulation. Italy suffered a major financial crisis a few years after deregulating it's banks. Perhaps most infamously, the S&L crisis under Reagan put the second dip on the 80s recession; in that case, though, nothing at all was accomplished and new regulations over savings and loans institutions were soon put in place. So high financial leverage and speculative investment was the result that could have been expected from deregulation over the following years, although not to the degree that it happened in Japan.
This bubble occurred across asset classes- banks and other investors made heavily leveraged forays into rapidly appreciating real estate and stock markets. After it burst from late 1989 to around February 1991, no one had the asset wealth to liquidate and pay back what they had thus borrowed, credit tightened dramatically and the economy fell into a slump for years with a great number of bankruptcies and deficient demand given the poor credit conditions. At least timely fiscal stimulus prevented this from becoming the Asian equivalent of the Great Depression. It will be a long time before the aftereffects of this crash completely go away but the Japan more or less recovered by 2003.
Large debt loads still hold back major firms, many of whom run profit margins of less than one percent and essentially stay operating by rolling over debt. The
keiretsu system, or the five major business groupings that dominate the economy, made Japan particularly vulnerable to this kind of crisis. In this model, encouraged in part by the Japanese government post-WWII and even before, each industrial group relies on a single bank. The grouped firms coordinate R&D and other services, and extract monopoly profit from domestic operations in order to compete internationally. When one of these banks makes poor investments, however, the rest of the
keirestu is badly disrupted. This organizational structure is slowly getting competed away by successful firms outside the system.
So to swallow all that up, yes, the Plaza Accord as originally designed likely was a big part of what happened. A "reverse Plaza Accord" was even drawn up in 1995 to correct some of the imbalances resulting from the original agreement to allow the yen to sink a little. Nonetheless, it's hard to really place blame or say anything that happened was avoidable. If Japan wanted to continue to maintain it's currency at extremely undervalued levels it would have found it increasingly difficult to do so, as became apparent by 2004 when the Bank of Japan finally abandoned active exchange rate intervention in the face of mounting upward pressure on the yen. In this particular case, forcing change on the currency manipulator was probably unwise since they were entirely willing to clean up their act on their own in a gradual but timely manner.
China is a different and less vulnerable beast. For one thing they have a marvelously strong - you could say nearly unstoppable- rate of growth in industry and productivity with a capacity utilization of just 60%. The government practically owns the severely constrained financial sector (which issues 98% of its loans to state-owned enterprises anyway) which generally doesn't dally in asset speculation. The measures I suggest (a 20% tariff on Chinese goods to match their currency devaluation) aren't particularly dramatic either given that their yuan is already strengthening. A little more domestic demand and a little less exports would almost help them. And the tariffs would bring in about $100 billion a year in federal revenue. What might be disastrous is if they continue to hold down the yuan for too long. It's slowly appreciating against the dollar, but could use a nudge.
And then we get into the geopolitical issue of how the Chinese would perceive such a measure and react to it.Like most policies which stand to make big waves it should be implemented gradually.
