Politik und Gesellschaft Online International Politics and Society 3/2000
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Wanted: An International Exchange Rate Regime
The Missed Lesson of the Financial Crisis
Heiner Flassbeckhe
Japanese slump leads to the most important question: Why is it that very different countries have been the subject of a banking crisis? On the one hand we have seen the failure of countries with large current account deficits and competitive weaknesses such as Thailand, Malaysia and Korea. On the other hand, and this is a neglected fact of the events which are called the gAsian Crisish, there is Japan - a country which got into trouble despite having a very high current account surplus and without having fundamental competitive problems. The remedy for the acute crisis in the gweakh countries had obviously been a sharp devaluation of their currency vis-a-vis the rest of the world. In Japan it is just the other way round. The Yen was strong most of the time and in the first months of 2000 Japan faces a revaluation that is not justified by the gfundamentalsh and that has to be fought by the central bank by buying foreign currency with Yen.
If a country has a weak currency because it has a grottenh banking system, how can a country like Japan have a very strong currency although it seems to share the same weaknesses with regards to the financial structures and the banking system? Thus, the conjecture of a grottenh banking system in Asia and of other gstructuralh problems around the world is not a convincing hypothesis. There must be other factors, beyond ?rottennessg, which explain the problems of the banking system and there must be other factors which explain the crisis in different gstructuralh environments.
The Japanese Yen and the Way into Deflation
Japanfs economy is in a deep crisis for the fourth consecutive year. Although there seemed to be the first signs of a recovery in the summer of 1999 the outlook remains rather bleak as there was a severe setback in the last quarter with overall GDP figures falling again. In the last years a lot of ideas have been launched to explain the persistent slump of an economy which, for decades, had been the role model for many gscleroticg economies in the Western World. Most explanations of the Japanese crisis focus on factors like a long isolated and inflexible banking system, the low profit margins of Japanese companies or the kind of cooperation between the government and the private sector which had indeed characterized the Japanese gmodelg.
The role of one factor, however, seems to be systematically underestimated: the exchange rate of the Yen. The Yen has wildly fluctuated in the last 20 years. However, erratic fluctuations are not adequate to describe what has happened in the beginning of that period. After the bubble in the stock and real estate market of the early 1990s had burst in response to a late but effective tightening of monetary policy, the exchange market entered the stage in an unprecedented and unpredicted manner. The nominal exchange rate of the Yen had already been overshooting the inflation and unit labor cost differentials with the rest of the world throughout the whole of the 1970s and the 1980s. The resulting real appreciation already falsified the traditionally held theory that the real exchange rate cannot have a trend. But after the sharp recession in the first two years of the 1990s things got even worse.
Between 1992 and 1995 the real rate of the Yen appreciated, according to different calculation methods, in a range of 50 to 100 %![1] Not one of the larger economies in the world has ever suffered from such an appreciation shock on top of a long phase of overvaluation. Germany, for example had a real appreciation of around 15% at the same time and was hardly hit by the consequent fall in export volumes, the loss of market shares and a rise in unemployment.
Figure 1:
A shock such as occured in Japan, but five to eight times that large would have led to a big crisis in every country of the world. Companies would have adjusted their labor force downwards, unemployment would have risen sharply, government deficits would have mushroomed. However, in Japan, despite the extraordinary dimension of the shock, neither a sharp drop in market shares nor a rise in unemployment can be observed. The growth rates of exports slowed down, but, according to OECD data, not even touched an absolute reduction. Employment stagnated but didnet fall. As unemployment hardly rose, the deficit in the public budgets increased slightly up to 1995, not even as much as in one of the major recessions in western countries. The shock is, however, clearly visible in non-residential fixed capital formation.
There is in my opinion only one explanation for such an outcome. Obviously, in the Japanese system, companies, for a remarkably long time, stabilized the system by bearing most of the unavoidable burden of the huge shock. Keeping the labor force, with the growth rates of total compensation per employee only coming down in small steps, means that the shock had to be absorbed for the most part by a profit squeeze. Such a profit squeeze would have led, again, under the auspices of a western system, to a sharp reduction of bank lending to companies due to much higher risk of default. In Japan, however, bank lending only stagnated at a rather late stage in the process. Close institutional relations of the banking system with the company sector and an insufficient supervision of banking activities have definitively played a role if we want to explain this kind of burden sharing. Only after the danger of major bank defaults appeared did the government have to step in and consolidate the banking system and thereby accept mushrooming budget deficits.
The conclusion of this analysis is not as simple as the one which is based on gstructuralg explanations of the Japanese crisis. Japanese or Asian institutional arrangements, i.e., the relationship between government, companies and banks, are not per se inferior to western ones. Given the size of the shock that the Japanese society had to absorb in one way or the other, any western economy would have tumbled, too. In western societies the government would have stepped in at an earlier stage and employees would have had from the beginning to shoulder a much larger part of the burden in terms of unemployment. In Germany, for example, the small, 15 % real appreciation induced a persistent debate about a fundamental loss of competitiveness and a lack of flexibility in the German society. With an appreciation of the Japanese size, most of the existing German institutional arrangements and achievements would have been put in question.
Thus, if adequate room is given in the analysis of the Japanese crisis is given to the external shock the Japanese economy faced in the first half of the 1990s the simple messages loose their persuasive power. Those who explain the visible weaknesses of institutions without taking into account the strain posed upon these institutions by external shocks, tend to overemphasize gstructural factorsg as well as gstructural remediesg. This may lead quickly to an govershooting effectg concerning the steps recommended to reform institutions.[2]
---------------------- Posted by Charles Jannuzi in Japan
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