Dr. Susmit Kumar, Ph.D.

 

[Note: When at one extreme we have the US whose economy works on “Ponzi Scheme” (i.e. it just prints papers (i.e. its currency) to funds its twin – budget and trade – deficits and then gets the same printed papers back as investment) and at other extreme China which is under-selling other countries by heavily subsidizing manufactured goods, “Free Market Economics” can never work at such a large geographical (, i.e. international) level.]

If economists claim that “Free Market economics” work, then why do they tinker with a free market and force country like Japan to sign the 1985 Plaza Accord? The US was taking care of Japan’s defense and hence Japan and other countries had to sign the accord, which led to the destruction of Japanese economy and salvation of US economy. If they would not have signed the Plaza Accord, the US dollar and US economy would have been history in the mid-1980s even before the fall of the Soviet Union!!! If Crude Oil prices would not have had collapsed in 1988 (after the end of Iran-Iraq War), then USSR would have still been here! The USSR collapsed because the crude price collapsed from $70 a barrel (at one point of time in mid-1980s) to upper one digit after the end of Iraq-Iran War. It is worth noting that even CIA (Central Intelligence Agency) of US had not predicted the collapse of Soviet Union. China can do the same with US right now, i.e. China can destroy the US dollar and the US economy whenever it wants (as per the 2009 Pentagon Economic Warfare Simulation).

 

After the collapse of the Nikkei average from nearly 39K in 1989 to 20K in 1990, which led to substantial non-performing assets of Japanese banks and nearly rock bottom interest rate of the central bank of Japan since then, all US economists and Wall Street pundits have derided the Japanese economy for the last three decades as Japan have not been able to recover since then. Recently, Lawrence Summers (US Treasury Secretary, 1999–2001 and former president of Harvard University,2001–2006), has termed the massive US Fed intervention to mitigate the Coronavirus carnage on economy as the “Japanification of the US economy” as the US is going to face the same situation for the next several decades (Larry Summers Says U.S. Economy Now Confronts ‘Japanification’, Bloomberg, March 12, 2020). But the US economists forget that it was the US who forced Japan to sign the 1985 Plaza Accord which led to the Lost Two Decade of Japan.

 

There is a major difference in "Japanification of the US" - Japan has been an exporting country throughout three decades and prior to 1985 Plaza Accord also. On the other hand, the US is an importing country for last nearly 50 years. Hence the moment the US dollar loses the status of global currency, the US might become a Weimar Republic as discussed in my paper China Has Capability to Make US a Weimar Republic and also in the 2005 article published in New York Times editorial page America's Truth Deficit, William Grieder, New York Times, July 18, 2005.

 

After the 1973 Arab-Israeli War, Arab countries imposed an oil embargo on the United States, raised the price of crude oil, and cut back oil production. Although they eventually ended the embargo, oil prices quadrupled within a few months to $12 a barrel. This led to oil rationing in the U.S. and inflation. During the Carter administration, inflation was running in double digits. After the 1979 Iranian Revolution, oil peaked at more than $39 a barrel. The high oil prices and inflation led to Reagan’s victory in the 1980 presidential elections. The Reagan administration instituted a policy of massive tax cuts to help counter the inflation but also increased defense expenditures, causing annual growth in the budget deficit. At the same time, American manufacturing jobs started shifting to East Asia, leading to an increase in the U.S. trade deficit. In order to reduce or finance the trade deficit, the U.S. had to either attract foreign investment by increasing interest rates or increase exports by depreciating the dollar. Increases in interest rates would adversely affect the domestic economy; hence, in order to depreciate the dollar, five nations—France, West Germany, Japan, the United States, and the United Kingdom—signed the Plaza Accord in 1985.

 

As per the accord, the Japanese yen appreciated rapidly and the dollar depreciated at a rate that led to the shifting of Japanese manufacturing plants to low-labor cost countries like Taiwan, Singapore, and then later on countries like Indonesia and Thailand. In the late 1980s, in order to stop further rise in the yen, the Bank of Japan decided on a low interest rate and spent yen to buy dollars in the currency markets. This resulted in increased Japanese investments in the U.S., fueling the “bubble economy” and a collapse of Japanese economy in the early 1990s. Nevertheless, Japanese money had propped up the Reagan administration, allowing it to operate in spite of budget deficits, as well as the U.S. economy in general. Had Japan not financed the budget and trade deficits at that time, Reaganomics would have collapsed. A similar situation is occurring right now, with China financing U.S. deficits. Japanese real estate prices skyrocketed in the late 1980s. The Nikkei (Japanese stock market) average tripled during this period. Total Japanese land values ballooned to a point where they were theoretically four times greater than those of the entire United States, even though the U.S. is 25 times larger and full of the natural resources that Japan lacks (James Fallows, Looking at the Sun, Vintage Books, New York, 1995, p. 10).

 

Due to the Plaza Accord, however, the dollar continued to slide in 1987, while the yen and German mark continued to appreciate, creating problems in international financial markets. To stop its slide, all G-7 members, except Italy, signed the 1987 Louvre Accord. Private investors exited the U.S. market as a result. In fact, during most of 1987, private capital ceased to flow to the U.S. on a net basis, and foreign central banks were obliged to finance roughly two-thirds of the $163.5 billion current account deficit. The Federal Reserve raised interest rates in autumn that year in a further effort to stem the dollar’s fall and calm financial markets. The Germans and Japanese offset the Fed’s action, however, by following suit, and the resulting flight of capital from U.S. financial markets triggered the October stock market crash (Robert Brenner, The Boom and the Bubble, Verso, London, UK, 2002, pp. 84-85).

 

Japan’s Nikkei reached all time high 38,957.44 on December 29, 1989, but it plunged by nearly 50% to 20,000 during the year 1990, hitting 15,000 by 1992. It has remained below 20,000 since then, trading between 10,000 and 20,000. The 1990s was called Lost Decade of Japan, a period of economic stagnation in Japan following the Japanese asset price bubble’s collapse in late 1991 and early 1992. The term originally referred to the years from 1991 to 2000, but recently the decade from 2001 to 2010 is often included (UPDATE 2-Japan eyes end to decades long deflation, Leika Kihara, August 12, 2012) so that the whole period is referred to as the Lost 20 Years. Broadly impacting the entire Japanese economy, over the period of 1995 to 2007, GDP fell from $5.33 to $4.36 trillion in nominal terms (World Bank), real wages fell around 5% (Waging a new war - Shinzo Abe wakes up to the political risk of higher prices without higher pay, The Economist, March 9, 2013), while the country experienced a stagnant price level (Historic inflation Japan - CPI inflation)

 

 

(Chart 1. Source: https://www.inflation.eu/inflation-rates/japan/historic-inflation/cpi-inflation-japan.aspx)

 

 

 

(Chart 2. Nikkei Historical Chart. Source: https://tradingeconomics.com/japan/stock-market)

 

In 1995, the Japanese banking system held some 100 trillion yen (20% of their GDP at that time or USD 1 trillion at 1995 exchange rate) in bad loans. Of the top twenty-one Japanese banks, thirteen were effectively bankrupt (Ulrike Schaede, The 1995 Financial Crisis in Japan, School of International Relations and Pacific Studies (IR/PS) BRIE Publication: Working Paper-85, February 1996, p.1; Dick K. Nanto, specialist in Industry and Trade Economics Division, Japan’s Banking Crisis: Causes and Probable Effects, Congress Research Report 95, October 6, 1995, p 34).