The most noteworthy commemoration of the second anniversary of Lehman Brothers’ collapse on Sept. 15, 2008, was Japan’s unilateral currency intervention to depreciate the yen. That move marks a shift in the character of the global financial crisis, away from concern with banking problems and toward a focus on the world’s dysfunctional exchange-rate system — or, rather, its current lack of one.
The Japanese intervention was immediately controversial. US politicians denounced it as predatory; Europeans saw it as a step on the road to competitive devaluations; and Switzerland’s central bank recently launched a costly and futile attempt to stop the Swiss franc’s rise against the euro — an effort that produced only large losses on its balance sheet.
Japan’s new activism was also widely imitated. South Korea and then Brazil started similar action to drive down their currency.
The 1980s was the last time anyone tried this sort of intervention. At that time, there was little agreement about its usefulness as a tool of international policy, and the G7 summit in Versailles in 1982 was extraordinarily conflict-ridden and unproductive. Indeed, it was to be the first act in a long exercise of futile mega-diplomacy.
The only concrete outcome was the commissioning of a report by a group chaired by a senior French civil servant, Philippe Jurgensen, on whether intervention was an effective instrument against the volatility that seemed to be undermining trade relations. When the report eventually came out, it acknowledged that “excess” volatility had “adverse consequences” for individual economies, as well as for the smooth functioning of the international adjustment process.
However, the Jurgensen report was ambiguous about the effectiveness of intervention. It stated that interventions aimed at objectives inconsistent with economic fundamentals were futile and counter-productive. The US read this as affirmation of its belief that all intervention was useless. Europe, especially in France, drew the opposite conclusion that intervention could be useful if it were intended to get exchange rates right. However, the report gave no guidance about how to judge whether exchange rates were appropriate or not.
The high watermark of intervention came a few years later, between the Plaza meeting of finance ministers in September 1985 and the Louvre meeting in February 1987. The Plaza meeting produced an accord on concerted intervention to push down the value of the US dollar, which all participants agreed was overvalued. The participants promised to use up to US$18 billion over a six-week period. However, in fact, the depreciation of the US dollar began well before the September 1985 meeting, and the meeting was limited in the sense that there was no discussion of monetary or interest-rate policy.
By the time of the Louvre meeting, the US dollar had fallen and the participants focused on “target zones” or “reference ranges” around a central rate. There was apparent agreement on a new wave of coordinated interventions, but the agreed exchange rates did not hold.
The Louvre agreement was not just ineffective. In retrospect, it was blamed for triggering a highly politicized debate about exchange rates, with every country trying to devise an approach that favored its own interests. The US, in particular, put enormous pressure on Japan to take expansive policy measures to relieve the pressure on the international system.
The resulting monetary expansion in the second half of the 1980s fueled Japan’s massive asset-price bubble, the collapse of which seemed to lead directly to the country’s “lost decade” of stagnation. As debate about Japanese economic decline intensified, a consensus emerged in Japan that outside pressure had forced the country into adopting a dangerous and ultimately destructive course.
The Japanese episode still echoes in modern debates. As the US pushes China to revalue the yuan, US economists try to support the case for a stronger yuan by looking at examples of surplus countries that adjusted by carrying out more expansionary policies.
The most extraordinary contribution to this debate has come from the IMF, whose April World Economic Outlook contains a chapter on how adjustment by surplus countries can be generally beneficial. The recommendation, which contains a long section trying to show that Japan’s 1987 and 1988 experience was not damaging, will be read in China simply as a statement that the US wants China to follow Japan in committing what amounts to economic hara-kiri.
That is not a helpful message, given the current state of the world economy. A more sophisticated approach is required. After all, the real lesson of the 1980s is that exerting massive pressure for exchange-rate adjustment and looser monetary and fiscal policy won’t work — especially since China now, like Japan then, is already running big budget deficits.
As exchange markets became ever bigger over the past 20 years, most commentators assumed that central banks’ ability to influence exchange rates through intervention had shrunk radically. We are in danger of forgetting that vital lesson.
The debate about China’s artificially pegged exchange rate has led Japanese Prime Minister Naoto Kan and French President Nicolas Sarkozy to begin to believe that they, too, might try shaping exchange rates. Indeed, Sarkozy has promised to make the search for a “better” exchange-rate system a key part of France’s agenda when it chairs the G20 next year.
However, the problem is that the world’s central banks do not sing from the same hymnbook. The political obsession with a better exchange-rate regime amounts to an invitation to private markets to make large amounts of money by betting against those central banks that are pressed by politicians to take a particular view of the exchange rate. The bankers will laugh, while politicians wail and gnash their teeth.
Harold James is a professor of history at Princeton University and the European University Institute in Florence.
Copyright: Project Syndicate
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