Tuesday, October 02, 2007

Can China avoid becoming the next Japan?

Brad Setser recently tipped readers to commentary by from Stephen Jen of Morgan Stanley as follows:
"Many in China have concluded that the blame for Japan's economic malaise in the 1990s lay largely with the appreciation of the yen. Beijing has therefore allowed the yuan to rise by only 10% since July 2005. But Japan's real mistake was its loose monetary policy to offset the impact of the rising yen—which further inflated the bubble—and then its failure to ease policy once the bust had happened. By holding down the value of the yuan and allowing a consequent build-up of excess liquidity, China risks repeating the same error."

I think Jen has the right idea here and gets to the heart of the problem that both China and Japan are in: they are caught between the Scylla of export decreases and hence negative GDP growth and the Charybdis of domestic inflation fueled by the desire for positive growth. You'll recall that in the early 1980's the US was in a somewhat similar situation with galloping inflation and due to a unique pair of strong leaders in Ronald Reagan and Paul Volcker, the political will existed to take the harsh economic medicine necessary to control inflation. I believe that Americans bought into that because President Reagan projected a strong sense of optimism about America's future and that absorbing problems in the short term would lead to long-term prosperity. Which I think has been borne out by subsequent American history.

This relates to the China vs Japan policy problem in that "Japan's real mistake" was the unwillingness to reign in monetary policy because it benefited vested interests. Which has led Japan to the fix it is in now. China needs to do something different or it will repeat the same error. The main wild-card for China is that taking the necessary economic medicine could lead to serious social instability.

Setser's stand-in over at RGE in recent weeks, Michael Pettis, has a very worthwhile post commenting that "
It is hard to overestimate the importance to China's near-term and longer-term prospects of the 17th Plenum in two weeks. These meetings, held every five years, are the main events of China’s political cycles"...Pettis further comments that
"the months leading to the congress are rife with factional infighting, sweetheart deals, attacks on frontrunners, corruption scandals, and the all-important maneuvering for promotion. Unfortunately, on the assumption that that any serious contender must at all costs avoid doing anything that may give rise to criticism before the promotions are decided, the period before the meetings tends to be a time in which very little, no matter how urgent, gets done"...

1 comment:

Anonymous said...

i must have made a mistake in my post -- the quote above is from the economist, not jen. I'll edit my post to make that clearer.

Brad Setser