Getting An Edge

By TAN Kee Wee
(MediaCorp 938LIVE’s Money Talks, Monday, 27 September 2010, 7.20 am, 9.20 am, and 7.20 pm)

In Formula One motor racing, millions of dollars are spent to make more powerful engines so that the racecar can go a split second faster.

In global trade, countries also compete to see who gets ahead. For political leaders, failure usually means unemployment and electoral defeat.

One competitive edge is a country’s foreign exchange rate. The weaker it is, the better for its exports. This is why the Bank of Japan recently spent billions to weaken its yen.

Japan is not the only country guilty of weakening its currency. The US is also guilty through its recent money creation process. And of course there is China, which is accused by the US for keeping its currency too weak.

In F1 motor racing, having the fastest engine doesn’t guarantee that you will win. Likewise, even if the renminbi were stronger against the greenback, it doesn’t guarantee that US exports would benefit.

That’s why China is resisting US pressure to strengthen the renminbi. China likes to refer to the Japanese experience to show why its stand is justified.

Twenty five years ago, Americans were equally upset with the huge flows of Japanese exports to the US. So in the famous Plaza Accord in September 1985, the US pushed Japan to strengthen the yen.

The idea was to reduce Japanese exports to the US. Japan agreed and the yen strengthened almost 50% from 1985 to 1987. However, instead of falling, Japanese exports to the US increased over the same period.

This is not to say that the Plaza Accord failed. It was successful, but over a much longer period. Between 1985 and today, the Japanese yen has strengthened almost 100%. Because of the stronger yen, the US trade deficit with Japan, as a percentage of US GDP, has fallen 66%.

The strong yen did not just reduce Japanese exports. It also encouraged Japanese firms to open factories in the US, thereby creating American jobs. Japanese workers did not protest then because their jobs were not at stake.

If the renminbi were stronger, the hope is that Chinese firms would also open factories in the US and hire Americans. But with so many Chinese unemployed, China is not likely to take this path.

The Plaza Accord has a dark side to it. Part of the agreement called for Japan to boost its domestic consumption. This is exactly what the Americans want the Chinese to do now.

After the Plaza Accord, things turned out badly for Japan. The Japanese easy money policies to stimulate domestic consumption led to bubbles in Japanese stocks and properties. Both these bubbles burst in 1990. The Japanese economy is still messed up till today.

It is easy to understand why China does not want to go through that. This is probably what Chinese premier Wen Jiabao meant when he said a few days ago (23 Sep) that a stronger renminbi of 20% would cause a “social upheaval” in China.

In F1 motor racing, like in any sport, if competitors feel that there is no level playing field, and all attempts to address the issue have failed, the only way out is to boycott the sport.

In the face of China’s stand, the US might choose to boycott trade or put up trade barriers. It did precisely that in 1930 with the Smoot-Hawley Tariff Act, and might do it again.

With so many Americans out of work, the mid-term elections coming, and his credibility plunging, President Obama could quote Wen Jiabao and say that, he too does not want to see “social upheaval” in the US.