Warnings for China in a dusty old book on Japan

Tom Holland
22 March 2010

“The world today stands at the brink of a depression that could equal or surpass that of the 1930s. The huge US trade deficits that have powered world economic growth cannot continue. At some point the United States must run a trade surplus, which means a swing in its accounts of roughly US$400 billion. If the world economy is not to come to a grinding halt, other countries must pick up this slack. With the world’s second largest economy, China is the prime candidate; hence the incessant demands from Washington that China stimulate its domestic economy.”

The paragraph above sounds depressingly familiar. It could have been lifted from any number of books, position papers or newspaper commentaries on the US-China relationship written over the last couple of years.

It could have been, but it wasn’t.

In fact it was written in 1988. All I’ve done is switch the target of the original writer’s complaints from Japan into China, and double the size of the swing needed to bring the US trade balance into surplus from US$200 billion to US$400 billion.

The paragraph in question is taken from the 1988 best-seller Trading Places: how America is surrendering its future to Japan and how to win it back by former US trade negotiator Clyde Prestowitz.

But although Prestowitz’s book is now more than 20 years old, its themes will be instantly recognisable to today’s readers.

At the time, the US seemed destined for terminal decline, its position as the world’s number one economic superpower threatened by a newly assertive Japan.

Directed by a powerful central government keen to promote “strategic” economic sectors and insulated from competition by protectionist barriers, Japan’s corporations were rapidly hollowing out America’s defenceless manufacturing industries, running up a huge trade surplus with the US in the process.

Meanwhile, with the fragility of the US model exposed by a shattering financial crisis – the Black Monday stock market crash of 1987 – Japan was fast achieving financial dominance over the US too.

Giant Japanese banks were snapping up stakes in leading Wall Street leading institutions, and the US government was becoming increasingly reliant on Japanese purchases of Treasury bonds to fund its budget deficits, prompting fears of further financial disaster should the Japanese stage a buyers’ strike.

“The United States look[s] ever more like a developing country. It imports high technology and capital from Japan and, aside from airplanes… exports to it mostly commodities, such as logs and soybeans,” Prestowitz complained.

Before they were even half way through his book, readers were left in no doubt that the American economy was doomed, and that in the 21st century the US would be little more than a subservient colony, dominated by an increasingly prosperous and powerful Japan.

Except of course things didn’t go according to Prestowitz’s script. What he had interpreted as Japan’s unstoppable economic rise was in fact a gigantic bubble. Within three years of the book’s publication, the balloon had burst, plunging Japan into a slump it is still struggling to escape 20 years later.

It is hard to avoid drawing parallels with today.

Given that China’s situation now is so similar to Japan’s in the 1980s, it is natural to wonder whether China is destined to follow the same economic trajectory: a meteoric rise, followed by a precipitous fall and decades of stagnation as the excesses of the bubble years are slowly worked off.

Lots of people think so. Yet a direct repeat of Japan’s boom and bust path is unlikely. Chinese officials have studied Japan’s history closely, and believe one of the main causes of the bubble was Tokyo’s decision to let the yen appreciate in response to US pressure.

As the second chart shows, between 1985 and 1990, the yen doubled in value against the US dollar. To lessen the impact on Japan’s exporters, the authorities kept interest rates low, fuelling the credit-funded orgy of speculation that ended ultimately in the great crash of the early 1990s.

It’s a course that Chinese officials are anxious to avoid following. They have read the books about Japan’s rise too, and they have concluded that if China is ever to achieve the economic dominance Prestowitz foresaw for Japan, then the one thing they must not do is to allow a rapid appreciation of the yuan. This time, they are determined, history will not repeat itself.

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